How far will the market fall? Let’s look at the S&P500 market levels and historic interest rates at a very basic, and superficial level. This may provide some insight for the size and direction of moves in the stock market.
Currently, the markets are volatile and trending downward due to rising interest rates trying to fight inflation. Fundamentally, the higher interest rates go, the less borrowing people want to do and slows economic growth. Additionally, investors can now invest money and earn 4% on high credit quality bonds, even higher for junk bonds. Investors will naturally continue buying fixed income the higher rates go, rather than having to buy into stocks to make up for low interest rate yields. Therefore, we might expect an increased amount of money in “safer” havens, compared to the stock market. Meaning stock prices should fall, as they have.
Now, let’s compare the latest peak of interest rates and crunch some numbers … July 2019, interest rates were 2.5%. Today they are 3.75%. The S&P500 was at 3,000 in July 2019 with 2.5% interest rates.
40% of all U.S. dollars were printed in 2020 due to the financial stimulus packages passed. In theory, the stock market would be valued at 4,200, adjusted for inflation in 2019 (i.e., 3,000 times 1.4.)
So the inflation adjusted market should be around 4,200. However, interest rates are 1.25% higher than 2019. If we take an arbitrary 1% interest rate increase equals a 10% stock decline (due to investors buying fixed incomes over equities), the market would be valued 12.5% less than the 4,200, adjusted for high interest rates.
Meaning, the S&P500 fair value should be around 3,675, assuming no growth in GDP from 2019-2022. Factoring in the 4% GDP growth from 2019-2021, the discount to the market should only be 8.5% from the adjusted 4,200. This would make 3,843 the fair value, assuming no more rate hikes and not factoring in economic contraction.
For these reasons, the market appears fairly priced at the moment, given the current information we are working with. What will happen next is anyone’s guess.
Expect continued market volatility until there is more certainty on inflation and interest rates. This volatility can be a great buying opportunity for those with long-term investment horizons, but a nightmare for near-retirees and retirees. All the more reason to work with a professional and construct a well-diversified, risk-adjusted portfolio to help stabilize the ups and downs of this chaotic market and sleep better at night.
*The information in this blog post is not kept current. The data used is from December, 19, 2022. This information is outdated and not current. No investment advice is contained in this post.*
Sources:
– https://fred.stlouisfed.org/series/FEDFUNDS
– https://fred.stlouisfed.org/series/M1SL
– https://www.google.com/finance/quote/.INX:INDEXSP?sa=X&ved=2ahUKEwjMhfPl04j8AhV_QzABHWXzBCIQ3ecFegQIGxAY