05/2024 - Know the Future
Full written article below.
Everybody knows exactly what’s going to happen in the future, that is, until it doesn’t.
Over the past two years there have been two very specific and very well documented economic events that were “sure” to have a known outcome. In both instances, the market forecasted were proven terribly wrong, as is almost always the case.
In this month’s newsletter, I’m going to highlight these two economic events, what the market thought was going to happen, and then what actually happened.
“Why go through the effort of talking what’s happened in the past? I want to know what’s going to happen in the future!” This statement is certainly a common sentiment.
The reason I’m going to outline these two different economic events is to re-enforce the reality for all of us that market timing is an exercise in futility. You’ll see how truly impossible it is for anyone to know with any certainty what’s going to happen and when.
Which in turn shines the light exactly on why it’s so critically important to develop a long-term financial plan which then determines a long-term investment strategy.
#1 Most Certain Federal Reserve Rate Cuts
None of us need reminding, but when Covid-19 hit, the Federal Reserve flooded the US economy with cash, which then caused a run-up of inflation. The basic definition of inflation was fulfilled as too many dollars (lots of cash) chased too few goods (sure to happen as many businesses were forced to close).
So when inflation ran hot, the Federal Reserve then stepped back in to try and clean up the mess they helped create by increasing interest rates. In fact, the interest rate increase has been the fastest on record for the Federal Reserve.
Visual Capitalist - Chart Source
Then – when the Federal Reserve increased interest rates, the overall market, proxy as S&P 500, dropped about 25% in calendar year 2022. At which point, in October 2023, it seemed to be as though “everyone” knew the Federal Reserve was about to drop interest rates.
An article from just 6 months ago, were being written about an almost “certain” 6 rate cuts from the Federal Reserve in 2024. Which then caused a surge in market prices with the S&P 500 rising about 27% from the end of October 2023 to the end of March 2024. Lower interest rates creates lower operating costs for businesses which means higher profits and typically higher company valuations.
You want to know the problem with all this? The Federal Reserve did not cut rates.
And now the assumption is that the Federal Reserve will cut interest rates by .75% over the next 5 Federal Reserve meetings in 2024. Source
Of course the begging question is… “so will this happen and how will my investments be impacted?”
Unfortunately, there’s no way to know the future, so nobody knows. But this is exactly why I don’t encourage anyone to try and out-smart or out-time the market. “Market timing is both impossible and stupid” – Warren Buffett
And this is exactly why I focus intensely on creating long-term financial plans which then dictate how we need to invest over long periods of time.
#2 Recessions Always Occur After a Yield Curve Inversion
This second economic event also focuses on actions from the Federal Reserve. To get a little nerdy in the investing space, there’s a historic trend that typically creates a recession. That trend is called “Yield Curve Inversion.”
This occurs when shorter year (duration) US Treasuries have a higher interest rate than longer year (duration) US Treasuries.
Another way to think about this is buying a CD from your bank or credit union. You’d anticipate that a 2 year CD would have a lower interest rate than a 10 year CD. That’d make sense. Right?
But what’s happening right now is the 2 year US Treasury is offering a higher yield (interest rate) than the 10 year US Treasury.
When this occurs, it’s called an inversion, and historically, when “yield’s invert” that typically indicates a recession is about to start. Why? Because if yields (interest rates) are lower on long-term bonds, that typically means there’s less optimism about long-term economic prospects.
And in late March 2024, we just passed the longest yield curve inversion in US history, source.
Again, historically, the last 6 recessions have been preceded by a yield curve inversion, see the Federal Reserve Chart (below) for reference.
So let’s go back in time to 2022, when the yield curve first inverted and let’s say you decided to get out of the market until the yield curve reversed. That would make a lot of sense, that is until you realize the market (S&P 500) climbed higher by about 36% over this same period of time!
It’s hard to articulate how many people and firms were “getting out” of the market during this terrific increase in value. In fact, one of the most prominent investment strategists at Morgan Stanley had to issue an apology letter for being just plain wrong, Morgan Stanley. One can only image how many millions and billions of lost value incurred by this un-forced error of trying to avoid a recession.
At this point I think it’s important to restate the obvious but often forgotten history of market returns and recessions. As you’ll see in the chart, a recession happens about every 6 years. Oh – and let’s not forget that from 1953-2023, the S&P 500 has returned 10.86% annually (with dividends reinvested) Source.
So can someone please tell me why Morgan Stanley is trying to avert a recession when they are all too common and have historically not stopped the long-term markets upward trajectory? Yes, I realize we all want to maximize upside and minimize downside, I just don’t see how it can be done with any consistency. Remember what Warren Buffett said about this??? Oh yeah… “stupid” – his words not mine.
Before moving onto my next section, let it be known that if you’re reviewing this data and have questions about how this impacts you specifically, please call or email. I look forward to talking with you.
Additional Data: Each month I get asked by clients what additional resources I’m looking at. Please hear me in stating I’m not trying to predict anything whatsoever, just some of the interesting data I’m watching.
- Gold, Real Estate, Bonds, Stocks Comparison – This chart create a visual representation of NYU’s research on asset class returns. If you look at the chart, you’ll see why I focus on stock returns, they simply out-perform everything else on this list.
- Presidential Election Concerns? – How will your investments perform with this or that President? A very normal and well-founded question. For anyone who has even had a hint of this question in their mind. Please do yourself a favor, take 5 minutes right now and read this short but effective article from JP Morgan.
- Federal Debt as Percentage of GDP – I think all of us will agree that Debt in this country is a problem, it’s been a problem and it’s a growing problem. This chart by the Federal Reserve puts the debt payments in reference to GDP. Helpful to put this in perspective.
- Trillions in Money Markets – At it’s highest level every reported, there’s 6.3T in money market funds, up from 6.1T last month. In the investing market, this is called “Dry Powder.” These are dollars enjoying higher levels of interest than in years past. But ask yourself, what do you think will happen when/if the Federal reserve starts to cut interest rates and banks start paying less in interest on these accounts? Do you really think people will just continue to hold their funds with less interest, or do you think they’ll look for other alternatives to make money? My guess is assuming interest rates come down, these people will start to move some of these funds back into the broader market. So what do you think would likely happen to market prices if this does occur?
- Breakeven Inflation Rate - 5-Year Breakeven inflation rate is now 2.34%. When you study this chart, you’ll see it goes back to 2004. Gosh darn close to the long-term average.
- Federal Reserve Balance sheet – For months the Fed was following through on it’s statement made in May 2022 of reducing the balance sheet by 47.5 billion per month in months June-Aug 2022, then reducing the balance sheet by 95 billion per month. But, just recently, you’ll see the balance sheet spike up by 300 billion with the new bank lending program but then a quick reversal. We’re now down to March 2021 levels and declining.
Market Truths
1. The Stock Market cannot be consistently known or timed
2. The Economy (as you define it) cannot be consistently known or timed
3. Over the past 100 years, the market has returned 10.45% (with dividends reinvested). It’d be difficult for someone to achieve this return if they did not simply stay invested. Data Source
4. The average intra-year market decline is about 14% and the market drops 15% or more every 3 years. J.P. Morgan | American Funds
5. Investing in equities has historically been volatile, my guess is it always will be, however when you consider equities (using the S&P 500 as a proxy), Real Estate, short-term bonds and corporate bonds, over the long-term, equities continue to be the historical winner. To crystallize this point, just look for yourself NYU.edu.
Market Beliefs
1. Because the future cannot be known, we must embrace the belief that the world isn’t going to end during our lifetimes, and if it does, our money doesn’t matter
2. The world has continued to advance, since well before Jesus walked the earth, so assuming the world doesn’t end, it’s rational to believe the world will continue to advance
In closing: We of course cannot control what the market does from here and we cannot predict when the next market downturn will occur. But we can control our behavior to these outside events and continue to stick with our long-term investment strategy.
As always, if you have any questions/concerns please contact me.
David Hobbs, CFP®
Wealth Advisor | Owner
Hobbs Wealth Management
Standard & Poor’s 500 (S&P 500) - a market-cap weighted index composed of the common stocks of 500 leading companies in leading industries of the U.S. economy.
Russell 2000 – The index measures the performance of the small-cap segment of the US equity universe. It is a subset of the Russell 3000 and includes approximately 2000 of the smallest securities based on a combination of their market cap and current index membership.
MSCI ACWI ex USA – The index measures the performance of the large and mid-cap segments of the particular regions, excluding USA equity securities, including developed and emerging market. It is free float-adjusted market-capitalization weighted.
Federal Funds Rate - refers to the target interest rate set by the Federal Open Market Committee (FOMC). This target is the rate at which commercial banks borrow and lend their excess reserves to each other overnight.
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