Short-Term Stock Market Outlooks Are Pessimistic

In this issue, portfolio manager John Deysher gives suggestions for dealing with the pain of investing. It’s timely since many of you are likely feeling some pain given the tough year the financial markets have experienced so far.

Misery is often said to love company. There are certainly many investors whose short-term outlooks for the stock market are pessimistic, if not gloomy.

We’ve seen this in our weekly Sentiment Survey. Those of you who have participated in the AAII Sentiment Survey have largely been downbeat. The streak of unusually low bullish sentiment readings reached 23 out of the previous 27 weeks as of mid-July. (“Unusually low” is a reading more than one standard deviation below the historical average of 38.0%.) Bearish sentiment has been unusually high for 22 out of the previous 26 weeks.

AAII members are not alone. Bears outnumbered bulls in the July 12 Investors Intelligence survey of newsletter writers, 40.0% to 32.9%. The TIM Group Market Sentiment, which uses advice provided by sell-side firms, was 48% (more bearish than bullish) according to the July 18 edition of Barron’s. Bank of America’s bull and bear indicator remained at “maximum bearish” as of July 19, according to Bloomberg.

We all know the headlines contributing to these readings. Inflation remains high. Gasoline is darn expensive. (Use apps like GasBuddy to find the lowest prices near you if you don’t have a Costco or Sam’s Club membership.) Interest rates are on the rise. The war in Ukraine continues. There is political disfunction across the globe. And, in the background of all this, there is chatter about the possibility of a recession occurring.

Whether the Federal Reserve will be able to pull off an economic soft landing remains the $64,000 question. The central bank’s rate hikes work on a lag basis, which is partially why inflation continued to worsen in June despite the Fed’s aggressive stance.

The bond market had yet to price in the probability of a recession as we went to press during the latter half of July. The yield curve showed some signs of inverting but neither the type nor the length is yet a harbinger of an economic downturn. You can see more on the yield curve in this month’s Dispatches.

The widely used rule of thumb for defining a recession is a decline in gross domestic product (GDP) lasting at least two consecutive quarters. The official arbitrator of such things, the National Bureau of Economic Research (NBER), defines a recession as “a significant decline in economic activity that is spread across the economy and that lasts more than a few months.”

Official definitions never stopped pundits from making their own recessionary calls—especially those seeking publicity, having something to sell or possessing a political axe to grind. Just as bear markets are a normal part of investing, so are recessions a normal part of the economic cycle.

While the bond market has done a good job of giving warning signs (a streak that could end at any time), the stock market has historically overreacted to the prospects of recessions. Economist Paul Samuelson’s 1966 quip about the stock market having predicted nine out of the past five recessions continues to hold true. As Kai Ryssdal likes to say on the Marketplace radio show, the stock market is not the economy.

If your inner Warren Buffett is saying “Be greedy when others are fearful,” consider listening to it. Bear markets have been opportune times to buy stocks. Plus, the second half of presidential terms have historically tended to be positive for the stock market.

But to get to the sunny skies, it’s possible that we may have to endure more storms. You can see Deysher’s tips on how to cope with investing pain here. You can also use bonds to reduce your portfolio’s volatility. Hildy and Stan Richelson make the case for buying bonds when interest rates are rising in an update to their 2013 AAII Journal article on the subject.

You can use the current downturn to make some savvy tax moves. They include doing a Roth IRA conversion before stocks rebound, harvesting losses and accelerating the timing of any planned contributions to your retirement accounts. (If you accelerate the timing of planned contributions, be sure to invest the amounts while stocks are on sale.)

Finally, the simple advice given in “The Hitchhiker’s Guide to the Galaxy” is worth following: “Don’t panic.”

Wishing you prosperity and good health,

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