Opinion – Grain in Grain: US stock market has the highest monthly increase in 9 months; see if it’s time to apply

The month of July is not over yet, but the American stock market, measured by the S&P 500 index, is already up 4.7% in the month until last Friday. This is the biggest monthly increase since October 2021. Right now, investors are wondering if the worst is over.

The S&P 500 accumulates a devaluation of 16.9% this year 2022. At the worst moment of the year, the accumulated decline exceeded 23% of devaluation. Many wonder if the American stock market would have reached its lowest value last month and would rise from now on.

The recovery that took place this month, when considering the exchange rate effect, encouraged investors even more. The devaluation of the Real contributed positively to international investment. Thus, the rise of the American index was 9.5% in July when evaluated in Reais.

To understand whether the worst is over and whether it is time to raise exposure to the US stock market again, it is important to understand what led the market to have this performance. Additionally, whether these reasons can be reversed in the near future.

It is possible to list four reasons that led the market to have a negative performance in the year, but there is a main villain among them.

The four reasons are intertwined: higher-than-expected inflation, rising interest rates in the US, economic slowdown and review of corporate earnings.

As can be seen in the chart below, US inflation is at its highest level in the last 40 years. She has been the main villain.

This inflation requires the Federal Reserve (FED) to raise interest rates. Rising interest rates should result in an economic slowdown. As a result of the latter, corporate profits are expected to fall.

Stocks follow the expected negative evolution of earnings. Additionally, higher interest makes the multiples, for example, Price/fair earnings of companies, lower. Therefore, pushing stock prices further down.

Knowing the four reasons, it is now necessary to understand how quickly they can dissipate.

In the pandemic, the market fell more intensely and faster than now.

You may not remember, but in the first half of 2020, the S&P 500 only dropped in the months of February and March. At a speed similar to the fall, he quickly recovered.

This quick recovery came as the medicine the Fed and the government applied to the economy was sweet. No one is embarrassed to prescribe sweet medicine in abundance. Fortunes of money were distributed to the population and interest rates were reduced to zero.

Now it’s different. The remedy is bitter, for the exact opposite must be done.

Nobody likes bitter medicine, nor any politician or leader wants to be the applicator of it.

In Brazil, we are more used to dealing with inflation. The Brazilian Central Bank has been tough in the fight against inflation and should continue to raise interest rates.

However, the Fed’s thrift in raising interest rates and reducing monetary expansion may cause inflation to fall slowly.

Thus, the reasons that led the market to fall should not dissipate anytime soon.

The appreciations that have occurred in recent years on the American stock market have caused many to reduce their perception of risk about it.

Warren Buffett argues that in the long run, the American stock market is one of the best investments. However, Buffett cannot invest in the CDI like you.

The high interest rates in Brazil also weigh on the short-term decision, that is, up to two years. This is a large opportunity cost that reduces the advantage of taking the risk of increasing exposure to the US stock market.

Indeed, the last decade’s return of the S&P 500 has been very compelling. In the last ten years, the American stock exchange yielded in Reais the equivalent of 21.9% per year. More than double the appreciation of the CDI. The exchange rate contributed with half of this appreciation.

However, the picture of the last 20 years is different.

Considering the devaluation of the Real, which favors international investment, the American stock market has appreciated by only 10.3% a year since June 2002. The CDI, on the other hand, has yielded the equivalent of 11.3% in the same period.

So for the past 20 years, it hasn’t paid off to take the risk of investing in the S&P 500.

Knowing that the last decade was great but the twenty-year period frustrated, can you imagine the disaster that was the decade between 2002 and 2012?

In this range, the average annual return of the S&P 500 was approximately zero. To be more precise, it was -0.2% per year. While the CDI yielded more than 14% a year between 2002 and 2012.

Therefore, at this time, thinking about increasing exposure to the US stock market should be well considered and would be more suitable only for risk-taking investors who have a long-term investment horizon.

Michael Viriato is an investment advisor and founding partner of Investor’s House

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