Broker Check

After The Emotion Wears Off, Stocks Almost Always Tend to Rise

| May 06, 2024

Not long ago, we at Cornerstone said to expect equities to go through a fragility test, given the dual risk of inflation resurgence and conflict in the Middle East. With a cooling-off period overdue, we expected stocks to face major deleveraging. But over the long term, we thought they’d come out the other side, surviving the test.

That belief was bolstered two weeks ago as markets reminded us that the “buy the dip” regime remains in effect as long as the Federal Reserve avoids hawkishness:

The “buy the dip” regime was a direct reflection of stocks only falling on bad news and not the sign of a market top where stocks fall on good news (i.e., good news is good news). March was good for stocks. However, let’s not discount April’s slide, especially the last trading day of the month, when the S&P 500* fell 1.6%, bringing the monthly loss to -4%.

Actor Matthew McConaughey summarizes the two-month period well:

But keep in mind, on April 19, the S&P 500 was down 6% for the month. So, the second half of April was positive, even if it didn’t seem that way, especially on a horrendous final trading day.

To put even more context into last Tuesday’s losses, let’s turn to employment costs. The "hotter" employment cost index for the first quarter came in at 1.2% versus a consensus expectation of 1%.

We think the market had an emotional overreaction to this report because when you dig down into the details, we’d argue wage pressures are not accelerating in the U.S. economy. Rather, the heated report was directly related to union pay surges (which are one time adjustments) while non-union pay decelerated.

The union-based uptick was an annual adjustment from new wage packages (chart below). It’s no coincidence the jump occurred in an election year.

Furthermore, Russell 3000# companies are at two-year lows of mentioning inflation or cost pressures in earnings calls (chart below). This is additional support for reality being at odds with first quarter inflation and wage data overall.

Last week, the other key event was the May Fed rate decision and subsequent commentary. As expected, the central bank announced no moves on interest rates or immediate expectation of moves. Of course, the key for the remainder of the week was how markets interpreted the news (the reaction was largely positive as rates cooled).

Regardless of the interpretation, as of the end of April, the federal funds rate futures already lessened expectations of cuts to around one for 2024 (chart below). But as we've said previously, no increase in rates is considered bullish.

The fact that there was selling last Tuesday going into the Fed meeting alongside a surge in rates tells us that any potential hawkishness by the Fed is priced in already. Thus, even the status quo creates a catalyst opportunity for the markets leading into May.

Lastly, after the April market consolidation, many investors might be tempted to follow the old saying, “Sell in May and go away.” But in the past 40 years, May data has been surprisingly good:

  • May returns are positive 77% of the time.
  • Not including bear markets, May returns are positive 79% of the time (we're not in a bear market right now).
  • After a positive first quarter and a negative April, May returns are positive 83% of the time.

Another McConaughey appearance seems appropriate:

While not a guarantee, the odds are in favor of strength over weakness in May, even though it might feel choppy. That said, the next week is important to determine the momentum-driven direction that the market takes based on the early seasonality data.

Emotional Overreactions Are Always a Mistake

With the recent escalation in geopolitical tensions, especially in the Middle East, we wanted to take the time to remind readers that geopolitical risks can flare up at any time. Still, it's important to remember that emotional reactions to such events are never the answer.

Geopolitical events are always a surprise, inherently unknowable, and as a result, are not priced into the market. That's why stocks initially sell off. When this happens, it's easy to overreact in the heat of the moment.

But as we know, emotional overreactions are always a mistake when it comes to the markets.

The latest geopolitical events are personal for me because I have family living in Israel. Obviously, my job is to be unemotional. So, I must be even more cognizant of my emotions and investment decisions, especially when trouble hits home.

In other words, the opinions we express in this blog and with our clients don’t exist in a bubble. This current situation is a real-life example of that fact.

Taking that into mind, especially on a personal level, I wanted to ensure we had an unemotional, data-based approach to what’s currently happening. Our friends at MAPsignals offered a helping hand.

After analyzing 29 geopolitical events since 1940, it’s clear that timeframes matter. What stocks do immediately following geopolitical events doesn't always reveal where they'll be once the chaos settles down.

Consider how the S&P 500 has averaged 1.4% and 1.1% drops, respectively, a week and a month after geopolitical events. Most recently, after Iran bombed Israel on April 13, the following week the index was down 3.1%.

However, on average, the S&P 500 gains 1.3% three months after a geopolitical event. Even better, it’s up 5.8% and 12.1% after six and 12 months, respectively, both of which are way above normal averages:

This objective data shows how stocks tend to bounce back quickly. On a more granular level, here’s how the S&P 500 has reacted to every major geopolitical crisis since 1940:

That table is a great cheat sheet for whenever geopolitical volatility strikes. It helps instill an objective, unemotional approach to investing in trying times.

History's verdict is crystal clear. While political uncertainty consistently drives short-term market volatility, soon after the emotion wears off, stocks almost always tend to rise higher.

 

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 * The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market.

# The Russell 3000 measures the performance of the largest 3,000 U.S. companies, representing approximately 96% of the investable U.S. equity market.

Securities sold through CoreCap Investments, LLC.  Advisory services offered by CoreCap Advisors, LLC.  Cornerstone Financial and CoreCap are separate and unaffiliated entities.