Why is the stock market down (and when will it recover)?

The FTSE 100 is down 3.5% since the start of the year. Despite a recent recovery, I think that the outlook for the stock market looks bearish in the near future.

In my view, the biggest cause of falling share prices has been inflation. This is giving rise to a number of problems that are weighing on stocks. 

Worse yet, I don’t see any significant signs of inflation going away. As such, I’m expecting share prices to stay low for some time.

Why is the stock market down?

Inflation has been the dominant macroeconomic theme of 2022, both in the US and in the UK. According to the most recent readings, prices in the US are 8.5% higher than they were a year ago. In the UK, prices are up by 10.1%.

High inflation levels create downward pressure on share prices for a number of reasons. First, they weigh on consumer spending. Second, they weigh on profit margins for businesses. Third, they encourage higher interest rates.

Daily essentials going up in price means that consumers have less to spend elsewhere. This is bad news for companies like Kingfisher and easyJet, which compete for people’s disposable income.

As more and more of their monthly salary gets taken up with food and energy costs, people are increasingly likely to delay or cancel home improvements or holidays. But it’s not just companies catering to discretionary spending that are under pressure.

Inflation is a problem even for companies that make everyday items, like Unilever and Kellogg. Higher costs of raw materials increases production costs, which results in worse margins and lower net income.

Across the board, inflation is therefore a problem for individual businesses in various ways. But it’s also a problem for share prices in general.

To try and bring inflation under control, central banks have been raising interest rates. But higher interest rates make stock returns less attractive by comparison, bringing down share prices.

When will the stock market recover?

I think that a meaningful stock market recovery is unlikely to happen in 2022. The main reason is that I think that inflation is likely to persist for some time. 

According to the most recent estimates I’ve seen, inflation figures are set to hit 18% at the start of next year. This is mostly the result of high energy prices.

Central banks have been raising interest rates to try and bring inflation under control. But there isn’t much that central banks can do about rising energy prices.

The reason that energy prices are rising so quickly is because of a supply shortage. This is the result of a few factors, most notably, the war in Ukraine.

The Bank of England and the Federal Reserve can incentivise consumers to save and try to slow down demand for consumer goods. But they can’t do much about the price of oil.

As a result, I don’t think that a meaningful stock market recovery is coming before the end of the year. Share prices might be volatile over the next few months, but I don’t think that a proper recovery is imminent.

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