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After worst stock market start in 50 years, some see more pain ahead

Wall Street set records in the first half of the year, none of them good.

The economy is on the cusp of a recession, battered by high inflation and rising interest rates, which are eating away at wages, shaking consumer confidence and driving business cuts. As it tipped, the markets crashed.

The six months to Thursday were the worst first half for the stock market since 1970. The S&P 500, the cornerstone of many stock portfolios and retirement accounts, peaked in early January and fell nearly 21% in course of the last six months.

The sell-off has been remarkably broad, with all sectors except energy down this year. Bellwethers, including Apple, Disney, JPMorgan Chase and Target, all fell more than the broader market.

And that’s only part of the horror story for investors and companies this year.

Bonds, which are seen as offering lower but more stable returns to investors, also had a terrible six months. Given that bonds are particularly sensitive to economic conditions, reflecting changes in inflation and interest rates more directly than equities, this is perhaps an even more worrying sign of the state economy.

An index that tracks the 10-year Treasury bill, a benchmark for borrowing costs on mortgages, business loans and many other types of debt, fell about 10% in price. Deutsche Bank analysts had to go all the way back to the late 18th century to find a worse first-half performance for equivalent bonds.

“Make no mistake, it’s been a scorching first half,” said Jim Reid, head of credit strategy and thematic research at Deutsche Bank.

For the average investor with a diversified portfolio of stocks and bonds, it seems “nothing has worked,” said Victoria Greene, chief investment officer at G Squared Private Wealth. This is especially true for investors who bought early in the year when markets were in a more buoyant mood.

“The venerable 60-40 portfolio hasn’t held up one bit,” Ms Greene said, referring to the mix of 60% stocks and 40% bonds that financial advisers have traditionally suggested to investors to protect them from risk. a downdraft.

Since the start of the year, stubbornly high inflation, now running at the fastest pace in over 40 years and compounded by soaring food and energy prices due to the war in Ukraine, has eroded corporate profit margins. This is on top of ongoing supply chain issues that have also made it harder for companies to fulfill customer orders and manage inventory.

Rising prices have also hit consumer spending, the foundation of the US economy. A government report on Thursday showed spending in May rose at its weakest pace of the year and spending on goods, where prices rose fastest, fell. Another recent report showed that consumer spending at the start of the year grew more slowly than expected. And a variety of gauges that track consumer predictions of how fast prices will rise in the future have also risen, a worrying sign that inflation could become more entrenched in the economy.

As investors reassessed the outlook, a few weeks ago the S&P 500 fell into a bear market, a rare and grim sign of pessimism, which Wall Street defines as a 20% drop from a recent high. The index has fallen in 10 of the past 12 weeks, with occasional rallies quickly dying out as a fresh wave of concern sweeps through the market. This has deterred companies from going public, with first-half IPOs proceeding at the slowest pace since 2009, in the aftermath of the financial crisis.

The Federal Reserve’s determination to control inflation by raising interest rates is a major factor in the current market turmoil. Fed Chairman Jerome H. Powell said on Wednesday that the central bank’s efforts to fight inflation were “very likely to cause pain.”

Higher borrowing costs cool the economy by lowering demand, which in turn reduces price pressure. Significantly higher bond yields, which move in the opposite direction to prices, have plagued bond investors’ portfolios with losses.

And if the Fed’s fight against inflation requires rates to rise so high, so quickly that the economy tips into recession, that would limit companies’ ability to hire new employees, spend on new projects, and pay off their debts, which bodes ill for stocks and bonds.

Assets thought to be immune to these trends also provided little refuge. Bitcoin, the largest cryptocurrency, has fallen over 50% this year.

Looking at the financial wreckage, the question arises: how bad could it get?

Over the next few weeks, companies will begin reporting their second quarter results, updating investors on the state of their finances. These reports will be scrutinized for signs that the faltering economy could worsen, which will be taken into account in buying and selling decisions.

As important as what companies reveal about their last quarter is what they say about how things are shaping up for quarters ahead, said Steve Sosnick, chief strategist at Interactive Brokers.

“In general, expectations remain very high,” he said. It’s either a sign that conditions may not be as bad as some fear, or they are about to disappoint. Analyst earnings forecasts for companies like Apple and JPMorgan have remained relatively flat over the past month.

Andy Sieg, chairman of Merrill Lynch Wealth Management, said he had not seen a major increase in trading activity among clients, which one would expect in turbulent times. There has, however, been a surge in the number of clients seeking financial planning conversations over the past year, which he described as a “constructive” approach to dealing with the recession.

“When markets are more volatile, emotions rise,” Sieg said. “It’s just a normal human reaction to the kind of environment we live in.”

Even if news about corporate earnings or the economy isn’t as bad as some fear, it may take time for the gloomy mood to change and what many believe to be another false dawn to mark a decisive turning point. “Typically, a bear market turns when the world still feels awful,” said Ms Greene of G Squared Private Wealth.

“There’s never just one real bottom,” said Interactive Brokers’ Mr. Sosnick. “It really is the final turning point. And so to me, it’s not clear that we’ve yet seen the circumstances that point to one.

For Deutsche Bank’s Mr Reid, “a lot depends on the timing of the recession”, he said. The fall in stocks so far would be an extreme outlier if it weren’t accompanied by a recession, according to his research.

Economists have raised the likelihood that the US economy is on the verge of entering a recession, and a shrinking economy is more in line with the extent of the market decline that Reid expects. He thinks it’s “plausible” that the stock market is down 35-40% from its January peak, meaning the current decline is only halfway done.

Ben Casselman and Jeanna Smialek contributed report.