Are We There Yet?
This is often a question asked of little ones on a long summer road trip. It’s hot, snacks are all eaten up, and we haven’t yet stopped for a while for fuel or charging.
Some investors may be asking this question as it relates to:
- When the Fed’s interest rate hiking cycle will be over
- When inflation comes down further
- Whether the markets will continue grinding higher or not
- Whether we will have a recession or not
Just like a long road trip, there are mountains to climb, low straightaways, and steep descents. But the journey, almost anywhere we travel, is somewhat familiar. One could even say there is something cyclical about it. There will always be highs and lows, and these can be observed in both the short term and long term.
We have the economic cycle – recessions and expansions. We have the presidential and mid-term elections. We have seasonality with earnings. We go through bear and bull markets. We go through monetary and fiscal tightening followed by easing. Tax hikes followed by tax cuts. We have inflationary and deflationary periods. With market technicals, we have pullbacks and throwbacks, resistance and support, and trends and countertrends. There are periods where mean reversion and momentum or growth and value take turns leading or lagging.
Let’s set the stage for where we are currently on our journey.
This has been a year where a lot of people have been wrong about a lot of things. Most prominently, many have called for a recession and for corporate profits to significantly drop. Others have called for credit spreads to widen and for the economy to buckle under the pressure of higher interest rates. Here’s the truth –
Consumers have been resilient in spending in the face of higher borrowing costs and the employment picture has by and large remained robust. In aggregate, companies have performed well, shrugging off much of the “bad news” that supposedly was coming. But most important, household finances have remained in good shape and sentiment hasn’t turned sour enough to significantly pare back consumer spending.
We think there are a couple of things at play here:
- While working from home has created some issues with commercial real estate in office buildings, workers have been able to save money (less money spent on gasoline and travel, and less eating out). Only during the recent summer driving season have we seen fuel expenses increase.
- Food and energy inflation in prior months have come down and so has the fear of spiraling out-of-control inflation, allowing consumers to spend in other areas of the economy. This helps the economy, but it also keeps inflation from falling faster.
- While higher interest rates can mean pain for borrowers, savers are making much more income now by holding money market funds and T-bills. More discretionary income from risk-free assets means more spending and better financial health.
For a few weeks now, some may have heard about seasonal weakness in the month of August. When we combine this with the current environment and how fast information moves and how fast sentiment can change, we can sense there may be some trepidation for investors to stay fully invested and the temptation is ever present to reduce risk, especially when one can make roughly 5.5% risk-free in T-bills.
Here’s additional context of where we’re at along with some market history from 1928 and on:
- We’re up more than 20% through July for the S&P 500.
- The “magnificent seven” or the seven largest companies of the S&P 500 are up more than 50% for the year while the equal-weighted S&P 500 is up less than 5%.
- Starting in 2023 realized risk was 103 and the current risk is 50 (as of 8/18/23)*
*Realized risk is derived from exponentially weighting the daily log return for the last 61 trading days with a 0.93 decay factor and then exponentially smoothing again for the last 10 days.
**The periods between 1949-1956 and 1982 through 1987 were long bull markets. The two instances where full calendar year returns were lower than through July of 1956 and July of 1987 were the Suez Canal Crisis and the Federal Reserve hiking rates and the Crash of 87.
While we sometimes catch ourselves asking “Are we there yet?” regarding the current market and economic environment, it’s helpful to understand that, like every cycle or season before us, we will get there. We should also understand that there are some silver linings currently:
- We have 100% of the time ended higher by the end of the year when the market is up 20% or more through July. On average, the increase from the end of July to the end of December is 9.45%.
- Pre-presidential election year returns such as this one have, on average, returned 6% more than the market.
- Performance has been better when realized risk is 65 or lower and performance has also been good when risk is falling below 100
- When we transition from a bear market to a bull market the average return for the first year of recovery is 29.14% and the second recovery year, on average, is 11.71%.
A look at long-term S&P 500 total returns indicates that the long-term trend for profit growth and the potential for wealth creation by continuing to own stocks is still intact, regardless of the changing of the seasons and the cycles. We are very close to the long-term mean (red line) and far from being significantly overvalued at one standard deviation (gray line above red line) or two standard deviations (green line above gray line).
Sometimes it takes longer to get to our destination than other times. Sometimes we get there quicker from exogenous or external factors while other times we get there from fiscal or monetary policy or other internal factors. But we always arrive, and we should always remember that the journey continues, just as financial goals continue through different stages of life. There will always be periods of easy-going and periods of rough-going.
We appreciate our partnership with you on this journey.
Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through WCG Wealth Advisors, a registered investment advisor. WCG Wealth Advisors and The Wealth Consulting Group are separate entities from LPL Financial.
Jim Worden offers investment advice through WCG Wealth Advisors, LLC a Registered Investment Advisor doing business as The Wealth Consulting Group. Jim is not affiliated with LPL Financial.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
All performance referenced is historical and is no guarantee for future results. All indices are unmanaged and may not be invested into directly.