We share a number of different charts and graphics during client meetings, so we are adding a monthly Investment Update Blog to capture the lessons and context provided by these slides for clients that we have not met with recently. For example, there are a few Market Update Slides that indicate we could finally be approaching a stock market environment that is no longer reacting to the uncertainty directly tied to COVID. The initial market drop of 34% in February and March of 2020 was an understandable reaction to the shutdown of the global economy in the early stages of a pandemic. Although it was surprising to see the stock market bounce back by 114% over the next 10 months, the combination of Fiscal and Economic stimulus from governments around the world created an environment where businesses were reopening and people were getting back to work with extra money in their pockets from stimulus checks while personal spending decreased significantly. Unfortunately, the reopening process ended up being over-exuberant as high inflation entered the picture in early 2022 leading to a market drop of 25%. After a slow but steady recovery during the past few months, the stock market is now back to the same trend line from when COVID hit in 2020.
The key questions that need to be answered to confirm that we have entered a post-COVID economy and market are centered on inflation and the Federal Reserve. Although inflation has dropped from 9% in early 2022 to 4% currently, the long-term inflation target is 2% which will require a delicate balancing act by the Federal Reserve to slow down economic growth without a recession. The Fed announced in early May that they are taking a “pause” before raising interest rates further, a well-deserved break after the most aggressive rate hiking cycle during the past 12 months in US history. Although the stock and bond markets expect the Fed to begin cutting rates before year-end, there is still a good chance that additional hikes will happen in July or August if inflation stays at elevated levels. Any additional rate hikes would lead to significant market volatility until alignment is reestablished between market expectations and economic reality.
We are optimistic that the markets and the economy could enter a post-COVID environment before year-end. That environment would no longer be dominated by questions about inflation or disrupted supply chains but would instead focus on historically low unemployment rates, rising wages, and strong corporate profits. The fundamentals are in place for a sustained market recovery which would echo prior market cycles with strong stock market returns in the first three years after a Bear Market like 2022. COVID has been off the front-page headlines for a while now, but the aftereffects of the economic and market impact are still being sorted out. Whether we enter a new market cycle in the next few months or in the first half of 2024, we see reasons to be optimistic about stock market returns over the next few years.
