Which Bear Market would you Choose?
Welcome to the August Newsletter! Looking for additional commentary? Watch the video that accompanies this newsletter as I always get off script from time to time.
Which Bear Market would you Choose?
Index Update (As of 07/31/2022 from Yahoo Finance)
S&P 500 (Large Cap): -12.62% YTD | +13.65% 10 Year Return
Russell 2000 (Mid, Small Cap): -15.43% YTD | +10.71% 10 Year Return
Global Market – ex US: -15.79% YTD | +5.43% 10 Year Return
Which would you choose?: At the end of June 2022, the equity markets were down about 20% YTD, now they are down about 12 - 14%. This of course is primarily driven by too high of inflation and high interest rates which is causing a re-pricing of investments we work with. While I fully realize being down 5, 10, 15, 20% and so on isn’t good in any sense, but let me ask a question.
Which would you choose?
Would you choose our current investment market that is lower because of self-inflicted wounds like printing too much money that has caused our current inflation? Or, would you choose another global health pandemic that saw equity markets drop about 34% in 33 days in 2020 (source: Yahoo Finance)? Or, would you choose a global financial recession that saw equity prices drop over 50% in years 2007-09 (source: Yahoo Finance)?
The choice is easy, I have to assume we’d all go with our current market sell-off.
This doesn’t mean I like our current market environment, but let me look back 50 years to include other seasons of high inflation. Since July 1972 to July 2022… (source)
- CPI is up 7.1x
- S&P 500 price is up 36.49x
- S&P 500 Dividends are up 20.9x
- S&P 500 Earnings are up 32.6x
Keep in mind that over this 50 year period of time the S&P 500 dropped about 50% on three separate occasions. It’s also worth mentioning that our economy has a bear market about every 4-5 years, as seen below.
Make it stand out
So let me ask this question… if we have a bear market about every 4-5 years, what happens the other years? My conclusion is we go up a whole lot more than we go down (Source: JP Morgan).
Are we in a Recession? According to NBER.org we’re not in a recession, at least not yet. The NBER looks at the “depth, diffusion, and duration” of the business cycle to determine if we’re in a recession. Recession or not, this doesn’t change our long-term investment strategy. Your investment plan with me is long-term and goal oriented. However, if your goals have changed, please contact me immediately so we can assess if your investment strategy needs to change as well.
Most clients ask the question… how long do recessions typically last? I think we should be asking how long in comparison to expansions after recessions typically last? As you can see from the below the Average recession length is 10 months and the Average expansion is 64 months. (source)
So how does inflation cool-off? The bad news with inflation is that it must run its course. The cure to high prices are…. high prices. High prices have historically curbed consumer demand because they simply can’t buy as much. Additionally, high prices also help to soak up the excess money in circulation.
Today, we certainly have high prices, and when looking under the hood at the level of money supply (M2), it does appear this figure is starting to cool off. The below chart is tracking inflation (red) and M2 in (black). (source)
Additionally, when I look at the 5-Year Breakeven inflation rate of 2.72% as published by the Federal Reserve, I have optimism that our current situation with high inflation is going to run its course and we’ll hopefully revert back to “normal.”
A final thought on inflation has to do with value of the dollar. Because we know that inflation is a decline in purchasing power, so it makes sense to think that with high inflation, the Global value of the dollar would go down, right? Well, it may surprise you that the dollar is close to a 20 year high in value and the Euro has lost parity with the dollar, first time since 2002 (source). A strong Global US dollar is something else that’ll help soak up the extra M2 that was printed in the past couple years. All-in-all, I feel these are good signs to help cool inflation.
Additional Data: Each month I get asked by clients what additional resources I’d encourage reading. This month I have three. Please hear me in stating I’m not trying to predict anything whatsoever, just some data I’m watching.
Retirement Expectations - CNBC – Overly concerned on Market volatility and under concerned on longevity
Profit Margins - Yardeni Research – Historically strong profit margins
Forward P/E - JP Morgan – PE ratios hovers at 25 year average
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, thank you for your trust, if you have any questions/concerns please contact me.
-Dave
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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