Three potential paths for the market


If you are confused by the stock market, you’re not alone. If you spend 20 minutes watching any of the financial news networks, you’ll be exposed to multiple opinions about where we are headed. Some think we are gliding in for a soft landing. Others say you should assume the crash position. And there are myriad opinions in between. To simplify things, I think there are roughly three potential paths the market could take. Two of them likely don’t pose long-term challenges to investors, but one does.

Charlie Farrell

Photograph by Ellen Jaskol

Charlie Farrell

Soft Landing. You’ve heard it time and time again from our government officials, but the Fed’s goal is a soft landing. What that basically means is the Fed wants to bring inflation back to 2% without meaningfully slowing down the economy or causing much of an uptick in unemployment. It could happen, but many things have to go right for the Fed. If the Fed can engineer this result, expect the stock market to rally and interest rates on bonds to fall. We’ll basically be back to where we were in 2019. I put the odds of this at about 30%.

Hard Landing. A hard landing means the Fed drives inflation down to 2% regardless of how much pain it causes the economy. That means we may experience a tough recession and a significant rise in unemployment. Traditionally, this is how the Fed solves inflation. The Fed must crush demand to see prices fall. And to crush demand, people have to lose their jobs. If not, consumers basically keep spending.  Because consumer spending is 70% of the economy, the theory is you can’t stop the inflation juggernaut until you stop consumers.

If we head down this path, expect the stock market to fall fairly significantly, somewhere between 30% and 50%. But, the good news is, if the Fed brings down inflation to 2%, markets should recover once it’s clear the inflation genie is back in the bottle. It won’t be comfortable, but the stock market declines should be in the rearview mirror within a few years.

I’d put the probability of this outcome at about 50%.

Stagnation. This third scenario is the more troubling one in terms of its potential impact on your retirement portfolio.  It’s possible we could head down a path where the Fed doesn’t bring inflation to 2%. It could happen a couple of ways. First, if the Fed can’t engineer the soft landing and decides it’s not worth the damage to push the economy into a deep recession, they may simply revise their goals. They could say something like, “We want to get to 2%, but not yet.” This leaves the 2% goal on the table, but pushes out the time horizon.

Conversely, the Fed may not be able to bring inflation to 2% even with a hard landing. There are many factors impacting inflation. If the Fed knew exactly what caused it, we wouldn’t have gotten any. So, it’s certainly possible given the complexity of global markets that just raising interest rates may not be enough.

I’d say the odds of some sort of stagnation are maybe 20%. It’s the least likely outcome, but the most troubling. A stagnation may cause investors to lose faith in the Fed and begin to rethink how they value stocks, bonds and real estate.

If we head down the soft or hard landing paths, investors probably don’t need to do too much. The market will likely recover, and all you’ll need to do is be patient and wait it out. In the stagnation scenario, however, the assumption that the stock market “always recovers within a few years” could be tested. Many people don’t remember that from the year 2000 through the end of 2012, the S&P 500 stock index had no price appreciation for 13 years. It had ups and downs, but at the end of that cycle, the market had actually gone down in price. This isn’t ancient history.


Source link