By: John Gonner, President & CEO and Chief Investment Officer
As of early June the widely followed U.S. stock market index, the S&P 500, is officially in a new bull market, meaning the index has risen 20% from its most recent low of 3,577.03 reached on October 12 last year. This ends the bear market that lasted just over nine months and saw the index decline by 25.4%. The rally in the index has come because inflation has improved significantly without the economy heading into a recession as many have feared it would, and because of excitement over AI (Artificial Intelligence).
Not all stocks have participated in this rally. In fact, all the gains for the index this year can be attributed to a very small group of stocks. In the first five months of this year, the S&P 500 Index was up 13.7%, but if you excluded just seven large tech companies (Apple, Microsoft, Google (Alphabet), Amazon, Nvidia, Facebook (Meta), and Tesla), the index would have been negative YTD. These companies have seen their stocks boosted by excitement over Artificial Intelligence. Without large tech and the AI excitement, the index would not be in a new bull market.
What is the “pain trade” in the stock market? The “pain trade” is a term used to describe a situation where a majority of market participants have positioned themselves for the market to move in a particular direction, only to see it move against them. Going into this year many people were worried that continued interest rate increases by the Federal Reserve would cause the economy to go into a recession and stocks would go down.
The Federal Reserve’s aggressive interest rate increases caused the yield curve to become inverted. An inverted yield curve is an abnormal situation where interest rates on shorter maturity bonds are higher than interest rates on longer maturity bonds. The inverted yield curve has historically been a strong predictor of a coming recession. Interest rate increases by the Fed also created a different problem. They created an environment which caused three of the four largest bank failures in our nation’s history to occur in a two-month period from early March to early May.
Higher interest rates on safe investments like T-bills and CDs have motivated a lot of individuals to move money out of the stock market into these safe investments, earning about 5%. But the economic data continues to be pretty good, and the recession concerns keep getting pushed back. The positive excitement over AI was enough to move the market up while many people are currently under-allocated to stocks. Now it looks like the Fed might be done raising interest rates. What if the recession doesn’t come and we actually have an economic soft-landing, where inflation comes down without a recession? The stock market could continue to move up and many people would find themselves missing out. They will be standing on the dock while the ship sails away.
This is why, even though the temptation can be very strong, the best move is to not change your overall investment mix from that which is appropriate to meet your long-term goals, regardless of the economic news. It is hard to do. But this is where the saying “it’s time in the market, not market timing that counts” comes from.