The S&P 500 Had Its Worst First Half Since 1970. What the Second Half Holds.

Investor sentiment has tumbled along with stock prices, and many market analysts expect the S&P 500 to slide some more. The 12 bear markets since World War II—not including the current one—lasted an average of 10 months from market peak to trough, with an average drop of 34%. If the current bear market were to follow this pattern, it wouldn’t hit bottom until October.

Even so, a rebound, when it comes, could be dramatic. Markets tend to perform the best when investors are the gloomiest.

With its 20.6% loss year to date, the S&P 500 posted its fourth-worst first-half performance on record, only behind 1932, 1962, and 1970, when it lost 45.4%, 23.5%, and 21.0%, respectively.

Other corners of the stock market are suffering even more. The small-cap benchmark

Russell 2000 index
is down 24% year to date, its worst first half since inception in 1984. That is a much larger drop than the previous records—the 14% fall in the first half of 2020 due to the pandemic shock and the 10% loss in the first half of 2008 amid the global financial crisis.

Meanwhile, the tech-heavy

Nasdaq Composite
has plunged 29.5% year to date, also the worst first half of a year on record since its inception in 1971. The sharp fall has outpaced the 25% drop in the first half of 2002 at the height of the dot-com bubble burst, and the 24% loss in the first half of 1973 after the U.S. stopped exchanging dollars for gold and saw a prolonged period of inflation.

Tech companies are experiencing a particularly steep dive, but there is hardly any corner of refuge in the stock market. The recession fear has pushed 10 out of 11 sectors into the red territory, led by consumer discretionary and communication services—things people often cut first when they need to tighten the belt. Consumer discretionary stocks in the S&P 500 have fallen 33%, while communications services are down 30%.

Energy stocks were the only ones that posted gains in the first half on the back of soaring oil prices, but even that sector has lost its momentum since June. Although energy companies are still pocketing record profits today, traders are quite aware that a recession would drag down demand, curb oil prices, and cut into their earnings. The S&P 500’s energy sector has tumbled 22% in the past three weeks, but still trades 28% higher than where it was at the beginning of the year. 

Although the overall market has performed better in the past two weeks, many are worried that things could take a worse turn in the second half of the year.

As of last week, 59% of investors were bearish about where the market is heading in the next six months, only 18% were bullish, according to a weekly sentiment survey from the American Association of Individual Investors. The bearish reading was the sixth highest since the survey started in 1987. At the beginning of June, just 37% were bearish while 32% remained bullish.

The fear of a lower market is largely due to anticipations of weaker earnings in the coming months. According to

Bank of America
’s
global fund manager survey in June, 72% of investors expect global profits to worsen over the next 12 months, up 6 percentage points from May and the highest level since September 2008. Investors are telling companies to “play it safe” and strengthen their balance sheets, rather than increase capital expenditure or deliver share buybacks.

“The bear market will not be over until recession arrives or the risk of one is extinguished,” wrote

Morgan Stanley

chief U.S. equity strategist Mike Wilson last week. A full-fledged recession could push the S&P 500 to bottom near 2900, or more than 23% below its current level, according to Wilson.

Other Wall Street giants have similar expectations.

Goldman Sachs

strategists said stocks are only pricing in a modest recession, leaving them open to a further worsening in expectations. Bank of America said the S&P 500 could bottom as low as 3000 in a worst-case scenario.

If there is any silver lining to these dim expectations, it’s worth noting that investor sentiment is often a contrarian indicator. Historically, unusually bearish sentiment—a sign of fear and cautious behaviors—tends to be followed by above-average market returns, while overly bullish sentiment—a sign of greed and risk taking—is often followed by below-average returns.  

Indeed, during previous years when the S&P 500 was down at least 15% at the midway point of the year, the index has finished higher in the final six months every single time, with an average return of nearly 24%. “Although most investors probably don’t feel like that is possible in 2022, just remember history says a surprise bullish move is possible,” wrote LPL Financial chief market strategist Ryan Detrick last week.

Citi

analysts, for one, believe the second half of the year could bring “low double digit upside” gains in the S&P 500. The market has mostly priced in the Fed’s planned rate hikes and their effects on stock valuations, wrote the analysts in a research note last week. Any signs of economic slowdown could help alleviate concerns about inflation and more hawkish Fed moves. 

Meanwhile, they believe that companies should have enough pricing power to pass the rising costs to consumers, which means margins might hold up better than expected. “Better-than-feared earnings and signs of peaking rates, combined with bearish investor positioning, support a positive [second half] risk/reward set up,” they wrote.

Although Citi has lowered its year-end target for the S&P 500 to 4200 from 4700, it’s still much higher than many of its peers. The index finished at 3785.38 points after Thursday’s close.

Write to Evie Liu at [email protected]