It’s the moment of truth for stocks—and investors might not enjoy what comes next.
For a moment this past week, the stock market felt like it was already there. On Thursday morning, the S&P 500 index, down 19.6% from its closing high, was inches from entering a bear market. The Nasdaq Composite, home to tech stocks that had driven the bull market, was plunging. Even Bitcoin joined the pity party by breaking $29,000 and falling to near $25,000. Everything seemed on the verge of collapse.
But the market didn’t collapse. Instead, Federal Reserve Chairman Jerome Powell seemed to acknowledge that maybe the Fed wouldn’t be able to engineer a soft or soft-ish landing, as he had so confidently claimed after the May 4 policy meeting. Instead, he said that a recession was possible and largely out of the Fed’s control. For a Fed that was thought to be singularly focused on inflation—economic growth be damned—it was a small, if nuanced, shift, which traders seized on. From Thursday’s low through Friday’s close, the S&P 500 gained 4.3%, and even the ARK Innovation exchange-traded fund (ticker: ARKK), home to so many beaten-down tech stocks, rallied 24%.
Still, it was a terrible week for the market. The Dow Jones Industrial Average fell 2.1%, while the S&P 500 declined 2.4%, and the Nasdaq lost 2.8%; but the week ended with enough optimism to ask: Is this the bottom?
History offers little help. If a drop of more than 19% but not quite 20% sounds familiar, it should. It was a level hit by the S&P 500 in 2018, before the Fed capitulated on tightening monetary policy, and in 2011, as the U.S. looked willing to default on its debt and Europe threatened to fall apart.
They’re big drops, says Doug Ramsey, chief investment officer at Leuthold Group, if not quite bear markets. Since 1957, the S&P 500 has dropped 19% 15 times. Five of those times were bottoms, with stocks bouncing immediately for an average 12-month gain of 23%. Five were followed by further double-digit declines, with an average drop of 32%. Eight were associated with recessions.
Many of the bottoms, however, were associated with Fed pivots, Ramsey says. In 2020, the Fed stepped in to backstop the markets when Covid shut down the economy, while in 1998, the collapse of Long-Term Capital Management forced the Fed to cut rates and fueled a massive bubble. But Ramsey thinks it’s unlikely the central bank will reverse course soon. “We already had a mind-boggling bubble, and the Fed is nowhere near a pivot,” he says, though he acknowledges it could change its mind quickly.
Still, it’s hard to see things getting much worse, at least in the short term, says Frank Cappelleri, chief market technician at Instinet. On Thursday, the number of S&P 500 stocks trading at 52-week lows hit their highest level of 2022 and are unlikely to increase much further, while the CNN Money Fear & Greed Index traded as low as two before closing at six, levels that can’t get much lower. Even the TICK Index, a measure of the number of winning versus losing stocks on the New York Stock Exchange, traded below -1500 for a sixth day in a row, a sign of extreme selling.
Such washouts can lead to quick moves higher—the S&P 500 rallied 10% from its trough on March 8 to its peak on March 30—but Cappelleri notes that big daily moves down and up, like those stocks experienced on Friday, need to stop if the market is going to make a sustainable bottom. “They show panic on both sides,” he says. “Neither is a healthy environment.”
Trade it at your own risk.
Write to Ben Levisohn at Ben.Levisohn@barrons.com