Oct 12, 2022 | insights

DALY ANDERSSON, CFA, CFP® FEATURED IN NEXTADVISOR - NASDAQ ENTERS SECOND BEAR MARKET: HOW EXPERTS PREPARE FOR STOCK MARKET VOLATILITY

By Harlan Vaughn

Nasdaq Enters Second Bear Market of the Year. How Experts Say You Should Prepare For the Stock Market Volatility Ahead

The Nasdaq Composite fell into a bear market for the second time this year on Tuesday, closing more than 20% below its recent high in August. 

The latest stock market drop comes on the heels of a brief rally last Monday and Tuesday, followed by a sharp drop last Friday as September’s jobs report spooked investors into selloffs.

According to the U.S. Bureau of Labor Statistics, nonfarm payrolls grew by 263,000 in September, while the unemployment rate slipped to 3.5% to match 50-year lows. This is not far from the projected gain of 255,000 new jobs. It’s also lower than August’s big 315,000 gain. 

But it’s still too large a gain for investors’ liking in another case of “good news is bad news.” As part of ongoing interest rate increases from the Federal Reserve – the last one happened on September 21 – investors are expecting jobless claims and unemployment rates to rise because they’re a gauge of how well the rate hikes are working to tamp down inflation. 

In short, fewer jobs and more unemployment would mean the measures are working. Today’s report sent the market spiraling down because it likely means the Fed will continue to aggressively raise interest rates at its next meeting from November 1 to 2. Getting inflation down will mean discomfort for the economy – and for investors, who are concerned higher borrowing costs will cut into corporate profits and lead to lower stock prices. 

The Fed is teetering in a gray area right now, says Daly Andersson, CFA, CFP®, co-owner and managing partner at Tenet Wealth Partners. “They’re trying to be diligent and have conviction of what they need to do, but they know it’s going to cause pain.” 

Moving forward, expect more volatility this month as investors wait for key inflation reports and the start of Q3 earnings season this week. Investors’ expectations of what the Fed will decide at its next meeting in November will also play a major role in shaping the market. 

We’re seeing market movements every day based on the news, whether good or bad, Anderrson says. That means investors can expect ongoing volatility “until we start seeing some real results with taming inflation.” 

What should investors do while all of this is happening? As year-end gets closer, experts recommend staying the course and dollar-cost averaging toward your long-term investment goals, regardless of what the market is doing. 

Historically, the market has always bounced back. Don’t change a thing, particularly if you have a long-term investing horizon. 

Why the Federal Reserve Is Raising Interest Rates Right Now

For the last year or so, plentiful jobs, high wages, and low interest rates have heated up the economy to a point where everyday expenses like food, utilities, and housing are now becoming more expensive. 

The Covid-19 pandemic also brought global supply chain shortages and bottlenecks, plus extra cash injected into the economy through stimulus programs, which spiked inflation in mid-2021.

Andersson says that “what we’re seeing now is that [inflation] is getting baked in – and we don’t want the cost of our goods and production to continue to rise at this level.” That’s where the Federal Reserve comes in.

Two of the Fed’s central mandates are to maintain low unemployment and keep inflation to a minimum. It does that through monetary policy, including adjusting the money supply in the country to make interest rates move toward the target rate the Fed sets.

Higher interest rates mean higher costs of borrowing for businesses and individuals, which should cool down demand and reduce long-term price growth. However, raising interest rates too high could potentially lead to an economic recession in the short term, which the Fed wants to avoid – but it’s a tricky balance to get right.

“When [the Fed raises] interest rates,” Andersson explains, “that’s going to slow corporate growth because [businesses] are not looking to borrow money at these high rates for growth or for capital expenditures. So, it has the impact of slowing [borrowing] down with the goal of slowing the prices of things around us.”  

Are We in a Recession?

The U.S. GDP contracted in the last two quarters, meeting the definition of a recession.

“By technical and historical definitions, we are in a recession,” says Linda García, founder of In Luz We Trust, a financial community geared toward Latinx investors.

Economists still say it’s too early to tell if we are in a true recession, but the technical definition of a recession is of little concern to Americans who are dealing with soaring prices, rising interest rates, and job layoffs. Q3’s GDP report is expected later this month, which should provide more clarity.

The labor market is caught between wage growth in some industries and layoffs in others. For now, it’s holding stronger than desired for the Fed, which wants to see the unemployment rate closer to 4%. It fell to 3.5% in September. 

You’d think higher unemployment would be a bad thing, but it’s counterintuitive. This is a case of “bad news is good news.” That’s because, as the Federal Reserve raises interest rates, investors want to see a softer job market – with higher unemployment – as proof that the rate hikes are working and inflation will finally start to fall. 

Because of these factors, García explains, the market is finding itself in a reset. It’s a great time to start investing in the stock market, especially if you’ve been watching from the sidelines for a while. “This is a really great opportunity for folks to either start learning about the market, start participating, or continue to be diligent in their monthly investments into the stock market.” 

Ups and downs are a natural part of the investing cycle – and if anything, right now is an excellent opportunity to keep dollar-cost averaging in broad-market index funds at a lower cost basis.   

Will the Stock Market Recover? 

“We’ve got all kinds of things that we’re trying to digest. And there’s a lot of uncertainty,” Andersson says. “Midterm elections, the Federal Reserve, corporate profits [are all] going on this year, just in this country.” 

The U.S. stock market is typically positive for midterm election years. In a few weeks, we’ll have election results and more economic reports to guide us through the rest of the year.

There’s also geopolitical uncertainty about the ongoing war in Ukraine and a potential energy crisis in Europe this winter. Global events impact our stock market, and inflation is persistent around the globe. 

Whatever happens, experts are expecting a volatile finish to the year – and where the market is headed is anyone’s guess. 

Keep in mind, investments easily outpace inflation over time – even with the normal ups and downs of the market. 

How Investors Should Deal With Stock Market Volatility
For new investors, big swings in the market can be a lot to handle. There’s a lot of uncertainty right now because of interest rate hikes, increasing real estate prices, and everyday commodities getting more expensive because of inflation — and the market reflects that on a day-to-day basis. 

But if you have a buy-and-hold strategy with low-cost, broad-market index funds, remember that slow and steady wins the race. The best-performing portfolios are the ones that have the most time in the market. 

“The most important thing is to always remember what you’re investing for,” says Thomas Muñoz, financial life advisor at Telemus, a financial advisory firm. “Short-term volatility is obviously something people should be aware of. But if you have a long-term time horizon, historically the stock market goes up. And when that’s the case, it’s important to have the discipline to keep dollar-cost averaging your [investments].” 

Dollar-cost averaging spreads out your deposits over time, and has demonstrated that it performs better “during a period of high market crashes,” says according to Rebecka Zavaleta, creator of the investing community First Milli. 

Whatever you do, invest early and often, especially if you have a long investment timeline. Dips and crashes will happen, and so will other scary-sounding things like economic bubbles, bear markets, corrections, death crosses, and recessions. 

You can even take advantage of a dip to invest more, but not if it impacts your regular investing schedule, Muñoz advises. It’s hard to tell when there’s going to be a dip or correction, and “not even the best investors in history can time the market.” As an investor, the best response is to stay the course and keep investing, despite what the market is doing.

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