BY: LINDA S. PARENTI, CFA - MANAGING PRINCIPAL
Successful long-term investors understand that not every year is an easy one. So far, this has been one of those years. With all the wild swings in the markets lately, it’s hard to believe the S&P 500 is only off by 1% month-to-date as of yesterday’s close and down 17% year-to-date. Even so, the equity index remains 69% higher than its March 2020 pandemic low. And looking back over the past three, five, and ten years, stocks have delivered an impressive annualized total return of 11% or better. Still, that doesn’t mean times like these don’t rattle the nerves of even the most stalwart market veterans.
Because of the latest inflation readings, analysts have been adjusting down their expectations that the Fed will pivot back to an easy monetary policy anytime soon. I would argue that analysts expecting a quick Fed reversal should be careful what they wish for. The Fed eases monetary policy by lowering short-term interest rates when the economy is too weak, and unemployment is too high. With inflation still high, a hasty Fed pivot would not be what the economy or the markets need in the long run. And even if rates rise further from current levels, they are still relatively low versus history. Given consumer demand remains reasonably firm due to healthy employment levels and higher wages, the economy should be able to handle higher interest rates for a time.
Still, Wall Street analysts have been fixated on the monthly inflation readings. While high inflation is currently an important problem, there are numerous measures of inflation reported each month. Placing too much emphasis on a single month’s reading of any one inflation measure is not particularly informative. The overall trend is more important than the absolute levels. And there is evidence to suggest that the U.S. economy may have seen the peak in inflation readings. It is also noteworthy that forward indicators show inflation is expected to continue lower in the years ahead. Yet, it will take months for confirmation that inflation is indeed headed in the right direction. Therefore, the real worry lies with how much monetary policy tightening the Federal Reserve will determine is needed to get inflation down to target and, in the process, will they slow the economy to the point of pushing it into a recession.
One of the most obvious signs the Fed’s tightening cycle is having a negative impact on the economy can be seen in the housing sector. Thanks to rising mortgage rates, mortgage applications are down sharply, both new and existing home sales are in decline, and housing starts have fallen sharply. Somewhat worrisome is that trouble in the housing market led the U.S. into the 2008-09 recession. However, even though the residential housing market has weakened across the country, there are solid reasons to believe we are not headed for another Great Recession. In the years prior to that period, there was a huge overbuilding of homes, resulting in simply too many homes available for sale. Now we have the exact opposite scenario, there are too few homes to meet potential demand. Higher wages and strong employment fundamentals should maintain a steady base of home buyers even with higher mortgage rates. Also encouraging is the fact that our banks are financially healthy. All 34 of the nation’s largest banks passed the Fed’s annual stress test earlier this summer, meaning they have enough capital to withstand a severe economic contraction and continue lending to households and businesses.
Unfortunately, market volatility is likely to continue at a higher level until we see a clearer picture on inflation trends. Rather than get discouraged, try to keep in mind that market volatility is normal. During market declines, it is important to resist the urge to sell. Some exposure to risk assets such as equities is essential to obtain the returns most of us need long-term. Correctly timing not only when to sell, but when to get back in is difficult. As clients, you are supported by a team that works to be sure your portfolios are appropriately diversified and in line with your long-term needs. It is also helpful to remember that as hard as bear markets are to endure, since the World War II, the average bull market has lasted more than 7 years longer than the average bear market. Over that time, the S&P 500 has risen 155% on average during bull markets versus an average decline of 30% during bear markets. We’re here to help you manage through the tough times.
Linda S. Parenti, CFA
RISKS AND IMPORTANT CONSIDERATIONS
Views and opinions expressed here are for informational and educational purposes only and may change at any time based on market or other conditions or may not come to pass. This material is not a solicitation to buy or sell securities and should not be considered specific legal, investment, or tax advice. The information provided does not consider the objectives, financial situation, or needs of any specific individual. All investments carry a degree of risk and there is no certainty that an investment will provide positive performance over any stated period. Equity investments are subject to company specific and market risks. Equities may decline in response to adverse company news, industry developments, or economic data. Fixed income securities are subject to market, credit, and interest rate risks. As interest rates rise, bond prices may fall. Past performance is no guarantee of future results.