While there’s plenty of reasons for the sell-off, investors’ concerns are for a potential top in markets given the growing list of worries about an economic slowdown and escalating military conflicts.  

Due to the pervasive bearishness that was present at the beginning of the year many investors were conservatively positioned and missed the large move up in equities. However instead of taking advantage of the current pullback, they continue to sit on the sidelines given the high level of uncertainty.  Amongst the topics of concern:

A possible US recession.

Inflation remains higher than central bank’s targets.

Higher interest rates for longer is the new mantra – worries that the economy cannot handle loan rates at this level.

Consumer debt is piling up. 

China’s reopening has fizzled and the economy is in the midst of a real estate crisis.

Bonds have had one of their worst performances on record and are no longer acting as a portfolio diversifier.

Private equity is struggling to refinance its loans.

Oil prices are high, putting further strain on consumers.

The Russia-Ukraine war shows no signs of ending.

US-China tensions continue.

The list above is far from exhaustive. And Trump may win the US presidency again next year, which may led to increased volatility.  To top the list off, we now also have an escalation in military conflict in the Middle East.

As Peter Lynch, now-retired star fund manager of the Fidelity Magellan Fund, once said: ‘far more money has been lost by investors trying to anticipate bear markets than in the bear markets themselves’. 

The concerns about the near-term outlook are all valid, but history shows us that equity markets have a strong tendency to climb a wall of worry, in other words continue to climb higher even when the level of uncertainty on the future is high. Counter-intuitively market peaks occur when investors are extremely bullish and there is no wall of worry present.  

Investors would be well advised to not rely too heavily on these negative outlooks. With all the attention that is being given to every CPI and US jobs number release, long-term investors should think back to any time in history where a particular economics report had a lasting impact on financial markets – it has never happened because it is all short-term noise.

Here’s a piece of data instead that is more useful. We’re now at the one-year anniversary since equity markets bottomed in October of last year, during which we’ve seen equity ETF inflows of US$317 million. There has also been $1.1 trillion of inflows into money market funds! This is the biggest flow of cash into money market funds in history. It hints that investors are worried about the future and view the security of a 5% annual return as attractive. But it also suggests that the proverbial wall of worry is extremely high, and that this cash on the sidelines can become pent-up demand to get back into markets when the outlook improves.

In addition, since 1952 US equities have not declined in a year when an incumbent President was running for re-election. This makes sense, as  Presidents want to be re-elected and will use all policy levers to boost the economy.

Despite (or because of) all this negativity, investors are forgetting that we’re still in a secular bull market, even though it does not feel this way.  While equities have been choppier than usual and posted negative returns over the last two years, as well as a three year stretch of flat returns up to the COVID bear market, they’ve continued to gain at a 7 per cent annualized rate over the last six years. Bull markets tend not to end when investors are worried and pessimistic about the future, they end when they’re euphoric and capital is cheap, with valuations at unrealistic levels.