For too many years Hollywood and their ilk have been purveyors of movies and serials depicting a wretched and dehumanized existence on earth. A fearful genre of aliens from other worlds wanting to destroy our Globe. Other dystopian conjurings, which are gobbled up across social and mainstream media are contributing factors for our polarized politics. No wonder people in general are anxious and depressed and specifically, the younger generation registering very high suicide rates. Investors are now hearing a dystopian outlook centering around ratcheting inflation numbers, higher interest rates, post COVID supply chain disruptions and Putin’s war crimes in the Ukraine. Is there any wonder the stock and bond markets have been correcting since early this year? A growing chorus of Wall Street pundits along with the many fearful investment newsletters are predicting doomsday. We reject the doomsday thesis and never embraced the dystopian trend of the past decade.
Setbacks are Temporary, Progress is Ongoing
When we look at all the setbacks and cynicism that’s so prevalent in our media, it starts to seem like that’s all there is. In fact, it’s important to note, that human beings are often prone to what behavioral finance refers to as “recency bias”. Behavioral finance is the study of how people make their financial decisions. Recency bias is our tendency to overweight more recent events when making decisions. For example, we may be more prone to conclude it’s not a good time to invest because of the recent headlines about inflation instead of considering the upturn capital markets have seen over the last 10 years. When you combine our proclivity to focus on the most recent trends and negative headline after negative headline, it’s no wonder many people are feeling down. But let’s look at some more long-term trends. Consider the improvements we’ve seen in healthcare. Is average life expectancy longer today than it was a hundred years ago? You bet it is! What about the advent of computers? Today’s minivans have GPS, Wi-Fi, back up cameras and the like. How does that compare with the most technology advanced machinery of, say the 1960s? Today’s minivans are more sophisticated than the Apollo rockets that were used to land on the Moon! Ultimately, all human history is a story of progress, admittedly with plenty of setbacks. We started in caves, then we became farmers, eventually we developed philosophy, mathematics, and written language, we’ve largely industrialized the entire world and, today, we can communicate with just about anyone on the planet almost instantaneously. What will be next? We don’t know for sure but, if history is any indicator of the future, and we believe it is, we can expect plenty of temporary setbacks and much more progress.
We believe there is a more enlightened view without being blindly pollyannish and to that end our thoughts and comments follow:
We have been in a reported disinflationary environment since the 1980s. The operative word here is reported. Modern inflation models use post World War Two industrial economy measures and in our view are missing important changes. Two examples have been higher education and health care costs both have been increasing at astronomical levels over reported inflation for decades.
It is true real inflation on food, fuel and labor services have escalated from the norm since COVID hit the global economy. The supply chain disruptions remain unresolved and are taking longer to fix. The current global warming trend is disruptive to crops directly or, indirectly by extending droughts where more water is desperately needed or creating too much rain where more water is not needed. Add regional wars and the disruption in rare earth minerals, phosphates as fertilizing agents and wheat for everyone’s daily sustenance of bread and the average person quickly grasps inflation.
The Federal Reserve is playing a little catch up in raising rates to counteract this wave of inflation. The Federal Reserve accommodative easing and driving rates to near zero was more than likely too long in duration. In our view it simply drove asset inflation into the capital markets (stocks and bonds) in part, and real estate, as, a whole.
In our view the Fed’s open market activities and raising the Feds fund rate while disruptive in the short term can be constructive for long term investors. The last time interest rates were trending higher 2016-2018 the Fed took rates from near 0 upwards of 2%. We believe it is a good thing when investors can earn 1-2% on their short- term credit instruments. This is more a return to historic norms versus the quantitative easing post the 2008 Global financial crisis.
NATIONAL DEBT AS A CEILING
Of course, few in Washington DC believe in a ceiling on the national debt, thus our $ 33 trillion of indebtedness. We want to suggest the ceiling concept is a de facto cap on how high interest rates may go. We just witnessed our 2- year treasury note moving from .6% to 2.6% this past quarter. It is difficult to imagine the two- year treasury note again doubling from here to over 5% and light of our present historic debt levels. At a certain interest rate inflection point a debt spiral is a real risk. A debt spiral is when total revenues are inadequate to pay interest on the debt, so more debt is extended. America has run debt over total GDP often, especially after WWII. However, in modern times we never went into the abyss of a debt trap spiraling downward. Ironically our irresponsible $33 trillion of debt may offer the benefit of limiting the absolute level of how high interest rate reach. Never any guarantees but an area we will watch closely.
Two consecutive down quarters of GDP is classified a recession. The old joke is the stock market has predicted twelve of the last nine recessions. Our view is a recession is part of the life of a business cycle and should be viewed as an opportunity to buy stocks as they retreat or stay fully invested for the allocation of long- term investment dollars.
This next chart demonstrates patience over trying to time recessions.
MARKET TIMERS HALL OF FAME
We are fond of saying “The market timers Hall of Fame has no one in it.” Please read that sentence again. In my 43 years in the industry of Wall Street there will be on occasion folks that can move in and out of markets with an apparent skill, luck or both. However, inevitably their system or styles cease to work on a lasting and enduring basis. We humans are just not very good at forecasting especially within a narrow time frame.
This next chart illustrates how being “out of the market” for just a handful of days can have a material impact.
THE BEAR DANCE
Technically a bear market is defined as when a decline of 20% or greater has occurred. The next aspect of a bear market is whether it is a cyclical or secular decline. The former is on average nine months the latter several years. The last time we had a bear market other than the March 2020 COVID crash (that was classified as a Black Swan event) was the stealth bear market of 2015. Many stocks declined greater than 20% but the indices heavily weighted by the FAANG stocks (Facebook, Apple, Amazon, Netflix and Google) muted the absolute decline. Today’s decline is not supported by these FAANG stocks as many of those cherished holdings actually began their decline early this year. It is currently too early to determine this will be a cyclical or secular bear market decline. However, if the broader markets were to further their declines it is ever more important to understand and keep a perspective of what is the aftermath, the inevitable rebound look like, and this next chart provides us with the three decline scenarios:
CONCERNS, CHALLENGES AND CLEARING THE PATH
In no particular order of risk magnitude, the following areas bear watching:
Areas of Speculation from Meme stocks, digital assets (crypto, NFTs) and Forex exchange traders often become dead weight when conventional markets have severe corrections. The trickle over effect can accelerate market moves. An analogy to the trend for outer space racing amongst a few billionaires is that all rockets eventually must come down.
Leveraged Funds and Trading Houses
When interest rates and yield curve have an abrupt and short-term move, regardless of direction we often times see these highly leveraged entities blow up. We have seen a couple in the UK and USA closing down this year already. Clearly there is less leverage in the banks and Wall Street firms since the 2008 Great Financial crisis. However, surprises can often emanate from lesser-known players and a domino effect is possible.
Mortgage Rates and Housing
The rapid rise in interest rates since February has virtually shut down the refi market for homeowners. Escrows for new purchases are subdued for lack of inventory in most markets. Mortgages north of 5% is still cheap historically but at certain levels it will impact affordability. Real estate in many markets has been appreciating at unsustainable levels so while rising rates and inventory increase will be welcomed to cool down this hot asset class, we do not expect a real estate crash of 15 years ago.
Clearing a path this past Tuesday Carson provided an All-Client Webinar to address the significant decline in stocks and bonds year to date. Burt White, the newly appointed Chief Strategy Officer and Jamie Hopkins, Managing Partner, Wealth Solutions offered an informative outline of the why, what and where investors find themselves at this juncture. They did an excellent job providing a historical backdrop with their slide presentations of graphs…a picture replaces a thousand words. For those who could not join us Burt, Jamie and Carson’s position is that inflation is closer to peaking versus escalating, the Federal Reserve has better than an even chance of navigating our inflation threat, the economy is very strong fundamentally, and if a recession does occur it should be shallow.
In summation we concur with Burt and Jamie’s take aways and we have always believed that dystopia is better in fiction than finance. Drawdowns are opportunities for long term investors and our team will be proactively addressing this with all clients in the days, weeks and months to follow. In the interim please call or email us with any comments, questions or observations. To watch a recording of their webinar, click here: https://carsongroup.wistia.com/medias/pf3l2wnpk3
Burt White and Jamie Hopkins are not affiliated or registered with Cetera Advisor Networks LLC. Any information provided by Burt or Jamie is in no way related to Cetera Advisor Networks LLC or its registered representatives.
This content is for general information only and is not intended to provide specific advice, an endorsement or recommendations for any individual. Past performance is no guarantee of future results. All indices are unmanaged and may not be invested into directly. Investing involves risk, including possible loss of principal. No strategy assures success or protects against loss. To determine what is appropriate for you, consult a qualified professional.
S&P 500– A capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.