The S&P 500 index is closely watched by investors all over the world. This is the benchmark for most equity portfolios, and it is viewed by many as the equivalent of the entire equity market.
So when the index underperforms for a long period of time, as it did in the first half of 2022, it means that stock market investors are in pain. But periods of sharp declines are not always followed by more declines.
In fact, history tells us that big drops to start a year tend to see big bounces back. For instance, in 1970, the S&P 500 index lost -21% in the first six months of the year – just like it did this year.
But for the rest of 1970, the index returned 26.5%. Since 1928, every drop by more than -15% in the first six months of the year was followed by a rally in the second half. Hence, if history tells us something, it is that now is the time to be invested.
A strong dollar weighs on the stock market
Two trends were obvious during the first six months of the year. One was the weakness in the equity markets, as illustrated by the S&P 500 decline. Another was the strong US dollar.
The divergence is more obvious when the two are on the same chart. While the S&P 500 index kept making new lower lows, the dollar index (DXY) surged.
Therefore, the central bank’s monetary policy is one plausible explanation for the weakness of the equity market. The Federal Reserve of the United States has raised the funds rate from near-zero levels and even delivered rate hikes bigger than the standard 25bp. For example, in June, it raised the interest rate by 75bp.
Moreover, it plans to hike by at least 50bp in July and probably by 75bp. Hence, the dollar index’s rally might easily continue.
But, as mentioned earlier in the article, the equity market tends to bounce after underperforming by more than -15% in the first semester. If the inverse correlation with the US dollar persists, it means that the DXY will reverse course too.
To sum up, the key stays with the Fed and how successful its fight against inflation is. If inflation cools down, the market will start pricing in fewer hikes from the Fed and thus, the S&P 500 index may outperform in the second half of the year.
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