The year 2022 is on track to be the third time since WWII the S&P 500 will be down 20 per cent, signalling the rarity of the decline and 10-month sell-off to date.

Investors have been dealt a tough adjustment with interest rates rising at the fastest pace we have seen by central banks, and global inflation remaining stubbornly high. The S&P 500 is down more than 22 per cent since the beginning of the year with just two months left, putting it firmly in bear market territory and on track to battle several more rate hikes to close out the year and United States mid-term elections.

When it comes to these periods the headline doesn’t always tell the full story. Some market darlings are down over 50 per cent from peak and recession risk debates now centre on whether we’re seeing a soft or hard landing for economies.

One quote used by Warren Buffett in his shareholder letter helps summarise periods in the market when fundamentals just don’t matter and weak investor sentiment or fear takes over.

“In the short run, the market is a voting machine, but in the long run it’s a weighing machine.” Benjamin Graham

Household names crushed

Leading global businesses in the S&P 500 down over 50 per cent or more from all-time highs (as of Oct 24, 2022).

• Facebook -66 per cent
• Tesla -50 per cent
• Nvidia -65 per cent
• Disney -51 per cent
• Nike -52 per cent
• Netflix -62 per cent

Share markets do have a way of looking ahead and pricing in macro issues, and 2022 has been no different. There is truth in the saying that “stocks look six months out” as the peak of the stock markets back on January 3, 2022 were well ahead of the 25 per cent drop in S&P 500.

Importantly, history has shown us with decades of data that companies with strong businesses and profits can survive and prosper. Just look at Apple and Amazon and the cycles they’ve been through as evidence of the highs and lows of investor sentiment.

Closer to the bottom

We have seen a dramatic adjustment in valuations from the major S&P 500 index that covers the largest 500 US-listed companies. The S&P currently trades for 15.5x of Wall Street’s forward 12-month estimates. This may be too optimistic still, but it’s down dramatically from the highs of 2021 and much closer to the long run average.

History indicates that once central banks move from their aggressive tightening of real rates, US stocks tend to do well and bottoms will form well in advance. Expect to see the stock market investors forecast the peak in real rates over the next six months, and rally in anticipation of declines.

Some bright spots

The US dollar has proven its status as king once again in 2022. Any position long USD has rallied very strongly, while locally the NZ dollar is down 20 per cent YTD and no different vs the AUD, JPY and EUR. Local holdings in US share markets have been somewhat buffeted by the strength of the USD.

Short technology companies and long energy has seen a very strong trade with geopolitics and rebounds following global lockdowns supporting demand.

Term deposit rates have surged from the lows of 2021, giving investors a more respective return on cash holdings. The search for yield has supported companies paying solid and reliable dividends, such as Spark in 2022.

Looking ahead

“The intelligent investor is a realist who sells to optimists and buys from pessimists.” Benjamin Graham

As we near the end of 2022, here are some useful signs to watch for.

• Central Banks signal pause in current cycle and communicate this.
• Inflation reports decline each quarter.
• Earnings for S&P 500 stabilise.
• US dollar declines from extended levels.
• GDP growth stabilises from declines.

My personal outlook for the next 12 months is that the S&P 500 will rise higher than today’s levels, but recession pain from the speed of interest rates moving from 0 per cent to 5 per cent+ will create distortions.

The attraction of cash will become a larger part of investor portfolios after 10 years of low term deposit rates; inflation will pull back (we’ve already seen some evidence of this); and central banks will have put rates on hold in the major economies. The US dollar will have peaked in 2022 and normalised to a level where importers and exporters are happier and no longer lopsided.

I expect Benjamin Graham’s quotes will prove true once again, both in guiding companies and the right mindset for us all to have.

Disclaimer: CMC Markets is an execution-only service provider. The material (whether or not it states any opinions) is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by CMC Markets or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person. The author does own shares in some of the securities mentioned.