Major stock market indices made significant gains in the first half of the year due to improving inflation, slowing Fed rate hikes, the absence of a recession, a more stable banking sector, and a strong rally in tech stocks. As of the end of Q2, the S&P 500 has climbed 16.9% with reinvested dividends this year, while the Nasdaq and Dow have returned 32.3% and 4.9%, respectively. Markets have recovered much of their losses from last year with the S&P 500 now 7% from its all-time high. Interest rates have also been steady after their sharp jump last year with the 10-year Treasury yield hovering around 3.8%, helping bond prices to recover as well. How can investors keep this recent market performance in perspective as we enter the second half of the year?
Given this strong year-to-date performance, many investors may be wondering whether this is truly the beginning of a new bull market or is instead a “bear market rally.” This is a shift from the concerns investors and economists faced at the start of the year when bear markets and recessions were top-of-mind. There are a few reasons why the past six months only further underscore the investment principles that long-term investors should follow in order to achieve their financial goals.
First, this year’s market performance is more evidence that investor sentiment can turn on a dime. The history of bear markets and short-term corrections shows that markets can turn around when it’s least expected, especially when investors are most pessimistic. This was true at the start of the year when few believed markets would ever recover, just as it was in April 2020, mid-2011, March 2009, October 1987, and so on. Each market downturn was driven by a real event such as a surge in inflation, the pandemic, the U.S. debt downgrade, the global financial crisis, or even Black Monday. However, in every case, investors expected these events to continue to worsen, even as fundamentals and valuations quietly improved.
This is why it is often better for everyday investors to simply stick to their well-crafted financial plans. By the time investors agree that a recovery has begun, significant gains have often been missed. This is not to say that downturns aren’t painful or that markets only go up. Rather, history shows that it’s often better to simply stay invested in an appropriately-constructed portfolio. In the worst case, investors who try to time the market and focus too much on short-term events completely miss the subsequent market recoveries.
Second, just as it’s difficult to predict the direction of the market, it’s difficult to know whether a particular rally is sustainable as it is occurring. This is why it’s often better for long-term investors to focus on the underlying fundamentals driving the rally. Even though markets can swing in either direction over the course of days, weeks, and months, steady economic growth and improving corporate profitability tend to drive markets higher over the course of quarters, years, and decades.
Thus, the importance of the economy remaining strong cannot be overstated. Only a year ago, the prospect of the Fed achieving a “soft landing,” i.e. that inflation would improve without a recession, seemed far-fetched to many. While core inflation remains a problem, the fact that overall consumer prices have shown improvement at a time when unemployment remains at historic lows is positive for markets. If and when corporate earnings begin to pick up, market valuations could become more attractive over time.
Finally, there are always reasons to see the glass as half empty, especially with many uncertainties still looming. Today, despite more stability in the financial system, there continue to be challenges in the wake of the bank failures earlier this year, most notably in commercial real estate. Upcoming refinancing activity could test the stability of the system as rates remain high and lending activity tightens. Additionally, while a debt ceiling crisis was averted, the can has only been kicked down the road to the beginning of 2025. In the meantime, geopolitics continue to be problematic as U.S. relations with China and Russia remain strained. Next year’s presidential election will also soon be at the forefront as markets assess all of these risks.
The bottom line: Experienced investors with a broad perspective on markets know that there are always risks that must be balanced against long-term returns. These risks often feel insurmountable as they are occurring. Once they are in the rear-view mirror, investor concerns often shift to whether the recoveries are sustainable. These back-and-forth swings in investor sentiment are a normal and natural part of markets and are why long-term investors can increase their odds of success by focusing instead on sound investment principles of prudent diversification, asset allocation, strategic rebalancing and adhering to a disciplined strategy.
Chart: Market Summary (Price Returns)
Sources for YTD Investment Returns: Clearnomics, Refinitiv
Disclosures: For informational and educational purposes only and should not be construed as specific investment, accounting, legal, or tax advice. Certain information is based upon third party data which may become outdated or otherwise superseded without notice. Third party information is deemed to be reliable, but its accuracy and completeness cannot be guaranteed. Neither the Securities and Exchange Commission (SEC) nor any other federal or state agency have approved, determined the accuracy, or confirmed the adequacy of this article. Investing is subject to risk, including the possible loss of the money you invest. Past performance is not a guarantee of future results.
