When trading closed last Friday (6/30/2022), the S&P 500 Index concluded its worst first half decline in 60 years. During the first six months of 2022, high inflation spurred the Federal Reserve to raise interest rates sharply which raised the risk of recession and dragged down the value of stocks.
This marks only the 6th time since the inception of the S&P 500 Index in 1926 that this benchmark for US stocks has declined by more than 15% in the first six months of a calendar year.
It is worth noting that in all of the five prior instances, stocks posted unusually robust gains in the 2nd half of the year.
The sample size is limited but it does support a useful reminder: risk and return are inextricably linked. When stocks go down, they get cheaper. When stocks get cheaper, their future expected return increases.
Investors all too often look at the stock market through the flawed lens of recency bias, expecting that the recent past offers a useful predictor of the immediate future. However, history provides evidence of just the opposite – that after stocks get pummeled, they generally bounce back. After stock valuations get cheap enough, long-term investors are often rewarded with outsized gains.
This is not to say that stocks provide bargain valuations or to make the case that the stock market is due for a 2nd half recovery. It is just a reminder that stock market losses often pave the way for stock market gains.
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