What’s Going on in the Markets January 30, 2022

With only one trading day left in the month, this January has seen the worst start to the year in the stock markets since 2008. Down just a tad under 10% year-to-date, after a stellar and steady 2021, could the auspicious start in the S&P 500 index portend a poor 2022 for the markets? After all, a popular market aphorism is “as January goes, so goes the rest of the year”.  Anyone who knows me well knows that I don’t ascribe much value to these popular sayings.

Much of the recent market volatility can be attributed to: 1) angst over COVID-19 variants; 2) worries about a federal reserve that has all but telegraphed 2-4 interest rate hikes in 2022; 3) the suspension of monetary stimulus (to combat inflation); 4) the absence of any significant fiscal stimulus expected from Washington; and 5) concerns over a potential Russian incursion into the Ukraine.

In this write-up, I’ll try to explain my viewpoint of what is going on in the economy and markets, and whether I think we’re heading for a much deeper pullback in the markets, or perhaps an economic recession.

Pullbacks, Corrections and Bear Markets

Enduring volatile markets is the price we pay for outsized returns that we ultimately earn for risking our money in the stock markets. Why even bother? Because cash and savings accounts pay us nothing, and bonds, which on average yield low single digit annual returns, ultimately lost a little money in 2021. Simply put, we need an alternative to stashing our money under the mattress. That’s especially true at a time when inflation is finally rearing its ugly head in a higher-than-expected way.

We need to invest in a way to at least overcome the depreciating effects of inflation on the buying power of our cash. Of course, we also need to be adequately compensated for taking the risk of investing in the stock markets.

In the media, you’ll hear about pullbacks, which is essentially any decline in prices of less than 10% from the last peak in the index, fund, or stock. Next, you’ll hear about a correction, which is a decline of 10%-19% in prices from the last peak. Finally, a bear market is a decline of 20% or more from the last peak.

2021 was such a smooth and steady uptrending year, where we barely had a couple of 5% pullbacks. By comparison, we generally experience between one and three 5% pullbacks a year. 2021 had no corrections, although we generally get one every 10-12 months. The last bear market we experienced came in February-March 2020 in the form of a 35% decline from peak to trough in the S&P 500 index, attributable to fears over COVID-19. We generally see a bear market every 3-7 years on average.

It seems obvious and unnecessary to state that the stock market is truly a “market of stocks”. Then why even say it? Because to understand what leads to pullbacks, corrections, and bear markets, you must drill down into the details of the indexes and see what’s really happening with individual stocks.

Despite an obvious uptrend in the indexes in 2021, digging into the details, you could see that there was trouble brewing under the surface. The number of uptrending stocks (stocks going higher) peaked in February 2021. So did the number of stocks making new 52-week (one-year) highs. At the same time, the number of stocks making 52-week lows bottomed and turned upward. A truly healthy market does the opposite of all this. But in fairness, after a very strong finish to 2020, the market was overdue in 2021 to take a "rest".

In stock market parlance, we call the number of uptrending stocks relative to downtrending stocks, and the ratio of stocks making 52-week highs relative to those making 52-week lows, components of “market breadth”.

For most of 2021, despite the stock market indexes making new highs on a regular basis, it was doing so with fewer and fewer stocks participating. An estimated 10%-15% of all stocks, which were quite strong, were masking weakness in the other 85%-90% of stocks. Small capitalization stocks, which make up the largest sub-segment of the stock market (in terms of number of stocks, not company size), peaked in March 2021 (note that small stocks attempted and failed in a rally attempt in November 2021).

All throughout 2021, we also observed more and more stocks making 52-week lows, and fewer and fewer making 52-week highs. Many stocks were down 20%-70% or more from their peaks, and those new low counts were increasing almost daily. Some COVID related and stay-at-home stocks which were the heroes of 2020 were being smashed. How can that be? After all, we were still making new market index highs on a regular basis throughout the year.

Without going into a long-detailed explanation about the structure of market indexes, let's just say that the biggest companies such as Apple and Microsoft (called large or mega capitalization stocks) have the biggest effects on the indexes, even if they are smallest in number. That’s how a cohort of 20-25 stocks could fool you into thinking that all was going great in the markets. Dig deeper--and you saw healthcare, industrial and communications stocks deteriorate as the year wore on.

If you wondered why your diversified portfolio didn't return anywhere near the returns on the indexes, the above partially explains it. If you didn't own enough of the chosen few outperforming stocks, your portfolio no doubt underperformed the market averages. That's called stock investing for the long term, and it's typical of many periods in the stock markets.

You’ll rarely if ever hear about the deterioration of market breadth on the evening news; you’ll only hear about new record highs in the indexes. Now you know a little better.

Pluses and Minuses

What does this mean for the market going forward? Are we headed for an economic recession? A bear market? Another double-digit return year? I’ll first discuss the pluses and minuses and then tell you what I see when I consult my broken crystal ball for the rest of the year.

Pluses

1. The economy is quite strong and continues to exhibit growth, with estimates of 3%-4% gross domestic product growth expected for 2022. Before COVID-19, our economy was growing at an annual rate of 2%-3%, but due to unprecedented stimulus, we have temporarily skewed the economic picture. I would expect the economy to return to normal levels of growth in 2023.
2. The job market continues to be robust and “tight”. Many more jobs are going unfilled than at any time in recent history, and that portends good starting wages for those looking for work. Companies that are expecting a recession would not be increasing posts for new and unfilled positions as they are right now. Higher wages mean that employees have more money to spend on goods and services, keeping upward pressure on the economy.
3. Earnings estimates for companies, which are the primary driver of stock market returns, continue to impress and increase over 2021 levels. Consumers are still spending strongly.
4. Many experts believe that the Omicron variant of COVID is the “swan song” of the disease, and that by mid-2022, the pandemic will be just another virus that is a part of our daily lives.
5. Traffic, travel, hospitality as well as office occupancy are slowly showing signs of returning to pre-pandemic levels in many major cities around the world.
6. Supply chain disruptions are easing around the world, taking inflationary pressures down with them.
7. Used car prices, a leading contributor to inflation, could be easing as semi-conductor chip production ramps up and finds its way into automakers’ cars waiting for delivery on their lots.
8. Consumer spending and demand for goods and services continues to be robust. Demand for travel and leisure services, considering the potential fading of COVID, can only be expected to increase.
9. The recent market sell-off has shaved off some speculative fervor from the markets, and the market is oversold on many metrics, which portends at least a short-term bounce (which may have started on Friday, January 28th).

Minuses

1. The strength in the economy could be hurt in the 1^st quarter of 2022 due to the Omicron variant disrupting production, increasing absenteeism, and reducing employee productivity.
2. Job growth and employee shortages contribute to wage inflation, which is the leading contributor to overall inflation. This will continue to pressure the federal reserve to increase interest rates to cool the economy. Higher interest rates reduce corporate earnings via higher interest expense, and implicitly lead to reduced stock price multiples (price-earnings ratio).
3. Although the recent sell-off has somewhat cooled the speculative fever in the stock markets, initial public offerings, special purpose acquisition companies, cryptocurrencies and non-fungible tokens, relative excess enthusiasm around speculation remains.
4. Housing prices may be in a bubble. With a continued short supply of available housing, this could also continue to exert upward pressure on housing prices for some time to come.
5. Monetary and fiscal stimulus, the prominent catalysts in one of the quickest recoveries from one of the shortest recessions in history (2020), looks to be notably absent given Congress’ failure to pass the Build Back Better stimulus bill last year. The likelihood of passing significant alternate stimulus legislation in a mid-term election year seems unlikely.

My Broken Crystal Ball Expectations

Normally, I try and avoid speculation about the future of the markets and economy, because I’ll just be guessing like anyone else.  But given that I manage million-dollar portfolios, and that I must make educated guesses about stocks, the markets, and the economy every day, I provide my thoughts for what they’re worth.

The weight of evidence points to a continuation of robust economic conditions that will lead to higher corporate profits. In other words, I don’t believe that 2022 will be the year we experience an economic recession.

This should lead to a stock market that’s higher at year-end than it is today. How much higher, if I had to guess, is probably less than 10%-12% from where we are today. That would mean we probably won’t make new highs in the markets for the rest of the year, which obviously means that I don’t think we’ll have a bear market this year.

Given uncertainty and angst over federal reserve short-term interest rate hikes and the ultimate lingering effects of COVID, I have near conviction that the volatility in the markets for 2022 will persist. That’s not saying much if I’m honest, because volatility is always expected in the markets. What I really mean is that the relative calm of 2021 won’t be repeated in 2022. But with volatility come opportunities to make new investments in stocks that become somewhat more fairly priced or undervalued.



As for the short term, Friday January 28^th saw a robust market bounce after a very tumultuous week. While the bottom of this correction may have been seen at the lows made on Monday January 24^th, we’ll only know that in hindsight in a few weeks. My best guess is that there may be one more re-test of that day’s low, but the real test right now is the robustness of the current bounce. If the recovery is solid and strong, then we may have seen the short-term lows for this correction.

Regardless, I don’t believe this means a straight up market and a full recovery of the immense damage done to tons of growth stocks, many of which won’t get back to old highs anytime soon, if ever.  If you’ve been nibbling on stocks into this decline, be ready to withstand a lot of back-and-forth action that will frustrate both the bulls (optimists) and bears (pessimists). "The secret to success in stocks is to not get scared out of them" - John Buckingham

If you’re stuck with poor performing investments, especially when you’re sitting on large losses, ask yourself whether it makes sense to sell them into the strength that any upcoming/current bounce ultimately provides. Don’t think that they’ll eventually and automatically come back, because many won’t. In general, I have a rule: if a long-term investment underperforms for 1-2 years after I buy it, it’s time to consider cutting it. Don't be too hard on yourself about it; just be ruthless in letting go of stocks that may have their best days behind them. Deploy the cash in better opportunities. If you found yourself too heavily invested coming into this decline, you may want to take advantage of the bounce to lighten up your exposure and take some risk off the table. Disclaimer: This is in no way investment advice or a recommendation to buy or sell any securities; please consult with your financial adviser (or us) for help.

For our client portfolios, we remain invested along with our portfolio hedges, which we adjust to changing market conditions. In addition, by using options to dampen volatility, reduce overall risk and generate income, we are well positioned to profit from whatever the year decides to throw at us.

For 2022, I believe that after 21 months of unusually calm and one way upward markets, this year will prove to be a more “normal” year with two-way market action, and likely single digit positive returns. But my crystal ball is still broken, so take this forecast for what it’s worth.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Inflation: Transitory or Here to Stay?

From leading indicators to business surveys to initial unemployment claims, the economic message is clear: The 2020 COVID-19 recession is over! Although the NBER (National Bureau of Economic Research) has yet to make their official announcement, my bet is that the recession ending point is backdated all the way to last autumn, or even earlier. That's how economics often works… with perfect 20/20 hindsight.

As the economy’s emergence from pandemic restrictions exceeds widespread forecasts and expectations, so do underlying pressures in other areas vital to the stock market’s outlook. And with the combination of a potential valuation bubble on Wall Street and corresponding housing bubble on Main Street, investor sensitivity to interest rates has never been higher.

In April 2021, the Consumer Price Index for All Urban Consumers (CPI-U) rose 0.8%, the largest one-month increase since August 2012. Over the previous 12 months, the increase was 4.2%, the highest year-over-year inflation rate since September 2008 (4.9% over prior 12 months). By contrast, inflation in 2020 was just 1.4%. ⁽¹⁾

The annual increase in CPI-U — often called headline inflation — was due in part to the fact that the index dropped in March 2020, the beginning of the U.S. economic shutdown in the face of the COVID-19 pandemic. Thus, the current 12-month comparison is to an unusual low point in prices. The index dropped even further in April 2020, and this "base effect" will continue to skew annual data through June. ⁽²⁾

The monthly April increase, which followed a substantial 0.6% increase in March, is more indicative of the current situation. Economists expect inflation numbers to rise for some time. The question is whether they represent a temporary anomaly or the beginning of a more worrisome inflationary trend.

Measuring Prices

In considering the prospects for inflation, it's important to understand some of the measures that economists use.

CPI-U measures the price of a fixed market basket of goods and services. As such, it is a good measure of prices consumers pay if they buy the same items over time, but it does not reflect changes in consumer behavior and can be unduly influenced by extreme increases in specific categories.

In setting economic policy, the Federal Reserve prefers a different inflation measure called the Personal Consumption Expenditures (PCE) Price Index, which is even broader than the CPI and adjusts for changes in consumer behavior — i.e. when consumers shift to purchase a different item because the preferred item is too expensive. More specifically, the Fed looks at core PCE, which rose 0.7% in April and 3.6% for the previous 12 months, slightly lower than core CPI but much higher than the Fed's target of 2% for healthy economic growth. ⁽³⁾

A Hot Economy

Based on the core numbers, inflation is not yet running high, but there are clear inflationary pressures on the U.S. economy. Loose monetary policies by the central bank and trillions of dollars in government stimulus could create excess money supply as the economy reopens. Pent-up consumer demand for goods and services is likely to rise quickly, fueled by stimulus payments and healthy savings accounts built by those who worked through the pandemic with little opportunity to spend their earnings. Businesses that shut down or cut back when the economy was closed may not be able to ramp up quickly enough to meet demand. Supply-chain disruptions and higher costs for raw materials, transportation, and labor have already led some businesses to raise prices. ⁽⁴⁾

According to the April Wall Street Journal Economic Forecasting Survey, gross domestic product (GDP) is expected to increase at an annualized rate of 8.4% in the second quarter of 2021 and by 6.4% for the year — a torrid annual growth rate that would be the highest since 1984. As with the base effect for inflation, it's important to keep in mind that this follows a 3.5% GDP decline in 2020. Even so, the expectation is for a hot economy through the end of the year, followed by solid 3.2% growth in 2022 before slowing down to 2.4% in 2023. ⁽⁵⁾⁽⁶⁾

Three Scenarios

As investors have become increasingly concerned about inflation, the Federal Reserve has given countless reassurances that current pricing pressures will be “transitory” and short-lived. Yet mounting evidence has seemingly turned this debate into the Fed versus the World.

Will the economy get too hot to handle? Though all economists expect inflation numbers to rise in the near term, there are three different views on the potential long-term effects.

The most sanguine perspective, held by many economic policymakers including Federal Reserve Chair Jerome Powell and Treasury Secretary Janet Yellen, is that the impact will be short-lived and due primarily to the base effect with little or no long-term consequences. ⁽⁷⁾ Inflation has been abnormally low since the Great Recession, consistently lagging the Fed's 2% target. In August 2020, the Federal Open Market Committee (FOMC) announced that it would allow inflation to run moderately above 2% for some time in order to create a 2% average over the longer term. Given this policy, the FOMC is unlikely to raise interest rates unless core PCE inflation runs well above 2% for an extended period. ⁽⁸⁾ The mid-March FOMC projection sees core PCE inflation at just 2.2% by the end of 2021, and the benchmark federal funds rate remaining at 0.0% to 0.25% through the end of 2023. ⁽⁹⁾

The second view believes that inflation may last longer, with potentially wider consequences, but that any effects will be temporary and reversible.

The third perspective is that inflation could become a more extended problem that may be difficult to control. Both camps project that the base effects will be amplified by "demand-pull" inflation, where demand exceeds supply and pushes prices upward. The more extreme view believes this might lead to a "cost-push" effect and inflationary feedback loop where businesses, faced with less competition and higher costs, would raise prices preemptively, and workers would demand higher wages in response. ⁽¹⁰⁾

Is Current Inflation "Transitory?

Dual surveys from the Institute for Supply Management (ISM) are ringing alarm bells, as the ISM Manufacturing Prices Paid Index has surged to one of its highest readings on record, led by widespread commodity price increases. As stated by one respondent to the ISM survey, “In 35 years of purchasing, I’ve never seen anything like these extended lead times and rising prices – from colors, film, corrugate to resins, they’re all up.” Likewise, even in the Service Sector the Prices Paid Index shot higher and is nearing a 25-year high.

Low inventories among companies that produce goods will undoubtedly keep price pressures high as companies scramble to replenish their depleted inventory and meet the unexpectedly high demand.” And prices have, indeed, continued to rise, while restocking efforts have been unable to prevent customer inventories from falling to a record low.

Central to the Fed’s “transitory inflation” argument is the belief that supply/demand pressures will quickly subside as inventories rebound. My concern is that broader evidence suggests inflation could be far stickier than the Fed expects.

From groceries to lumber to cars and even chickens, inflation pressures are being felt by consumers and businesses. The widespread nature of today’s inflation is one of the factors that suggest pricing pressures may be more deep-rooted than the Fed believes.

Perhaps most importantly, business owners are also facing higher wage costs as qualified labor is becoming an increasingly rare commodity. The National Federation of Independent Business (NFIB) reports that a record 44% of small businesses have unfilled positions, and over half of those with job openings reported that there were few or no qualified applicants.

Historically, wage inflation can be notoriously sticky, and the disparity between the NFIB Job Openings and reported Wage Inflation is a gap that will almost certainly be closed in the year ahead. This casts further doubt on the Fed’s narrative that inflation will surely be “transitory.” And unfortunately for the Fed, wage inflation–once ingrained–can typically only be reversed by a recession.

As businesses are facing higher input expenses, they are already making plans to pass these costs on to their customers. The National Federation of Small Business' survey of small businesses shows that plans to raise selling prices have reached the second highest level since 1981 – a time when inflation was running near 10%.

Maintaining Perspective

Although it's too early to tell whether current inflation numbers will lead to a longer-term shift, you can expect higher prices for some items as the economy reopens. Consumers don't like higher prices, but it's important to keep these increases in perspective. Gasoline, jet fuel, and other petroleum prices are rising after being deeply depressed during the pandemic. Airline ticket prices are increasing but remain below their pre-pandemic level. Used cars and trucks are more expensive than before the pandemic, but clothing is still cheaper. ⁽¹¹⁾ Food is up 3.5% over the last 12 months, a significant increase but not extreme for prices that tend to be volatile. ⁽¹²⁾

Anyone who has tried to buy or build a home in the past six months is aware of the rising stresses in the housing market. Home prices are soaring, not only here in the U.S. but on a global basis as well.

History has shown that it will be difficult, if not impossible, for the Federal Reserve to dampen or halt the imminent impact of the red-hot labor and housing market on the economy. Any cost surprises will undoubtedly be to the upside in the months and year ahead, and that does not bode well for inflation news OR for the Fed’s reassurance of “transitory” inflation.

For now, it may be helpful to remember that "headline inflation" does not always represent the larger economy. And with interest rates near zero, the Federal Reserve has plenty of room to make any necessary adjustments to monetary policy.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Projections are based on current conditions, are subject to change, and may not come to pass.

1, 12) U.S. Bureau of Labor Statistics, 2021

2, 4) The Wall Street Journal, April 13, 2021

3, 6) U.S. Bureau of Economic Analysis, 2021

5) The Wall Street Journal Economic Forecasting Survey, April 2021

7, 10) Bloomberg, March 29, 2021

8) The Wall Street Journal, April 14, 2021

9) Federal Reserve, 2021

11) The New York Times, April 13, 2021

Life After COVID-19: Same As it Ever Was?

And you may find yourself
Living in a shotgun shack
And you may find yourself
In another part of the world
And you may find yourself
Behind the wheel of a large automobile
And you may find yourself in a beautiful house
With a beautiful wife
And you may ask yourself, well
How did I get here?

...

Same as it ever was?

 

Once in a Lifetime Song Lyrics by the Talking Heads

 

After weeks of quarantine and “stay at home” orders, we are starting to see encouraging signs of progress in our fight against the COVID-19 pandemic. While we are not out of the woods yet, our collective focus seems to be shifting to what life looks like after COVID-19.

We're all eager to go back to some sense of “normal”, but some experts believe the COVID-19 global pandemic will cause permanent changes in our lives, our psyches, and in the normal way business is conducted in America and around the world. Will we ever go back to the way we were before the virus struck?

Same as it ever was?

Our world could change in many ways beyond our current social distancing and wearing masks in public. Companies large and small are overcoming their reluctance to allow employees to work remotely. Business travel and conferences could become more virtual and less in-person events. Schools from elementary to college have been forced to accelerate online learning capabilities that could change the future of education.

Everyone is becoming more comfortable with virtual meetings, using services like Zoom, Google Meet, GoToMeeting, Slack, and Microsoft Teams for everything from business meetings to exercise classes. Online shopping had already seen rapid growth in recent years, and with physical stores closed, that growth has exploded.

A catastrophe on the scale of the COVID-19 pandemic can also change the psyche in interesting ways. We can see this impact in the people who survived the Great Depression and the rationing during World War II. The most telling residue of those times was people living frugally for the rest of their days, right through a long period of abundance. At the very least, people will have an enhanced appreciation of things we once took for granted.

As we return to some form of “normal,” we need to ask ourselves some important questions. We should think about what our world looks like during this “Great Pause” and use that to make smart decisions about what we want it to look like in the future. Celebrating the 50th anniversary of Earth Day brought plenty of commentary about the benefits of less traffic, smog-free cities around the world, and the return of native wildlife to city streets.

Same as it ever was?

On a more personal level, can YOU take advantage of this incredible opportunity we have been “given” to think more deeply about what you want YOUR life to look like after the pandemic? Maybe jumping right back into the life you had before is not the answer. Perhaps you could make some changes that would improve your life and enable you to live more aligned with your true purpose?

Thinking about questions like these might help as you consider what your life looks like after the pandemic:
1. What brings you joy? What percentage of your time, money, and energy are you putting into people, experiences, work, etc that bring you true joy?
2. What have you truly missed during these past few months? How can you make changes that might enable you to spend more time in these activities?
3. Are there any things you've found you really do not need in your life? We often fill our lives up with so many activities and so much “stuff” that we constantly feel overwhelmed. Maybe some of that “stuff” is not important in the long run.
4. How can you make a real difference in the lives of others that you are close to? Maybe your perspective on this has changed during the pandemic.

While my role as a CPA & Certified Financial Planner is typically focused on the financial side of my clients’ lives, the real reason for addressing these financial issues is to help you live the life you desire. That is the true purpose of financial planning. We help you think through the financial issues, concerns, and questions that you face and assist you in making smart decisions in your financial lives. We all must make choices and trade-offs in our lives, and our role is to help you think through the financial implications of doing that. But the ultimate goal is to help you live the life you desire.

I am here to help you as we all transition to life after the pandemic. All our lives will be different going forward, maybe you can make yours a little better. There is so much that is out of our control in times like these, by focusing on the things that we CAN control we can lead a better life.

Same as it ever was?

Probably not.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

What's Going on in the Markets September 9 2016

On Friday September 9 2016, the S&P 500 index fell 2.4%, while the Dow Jones Industrial Average fell 2.1%.  This was the first "greater than 1%" sell-off since June, its worst single-session loss in more than two months. The drop ended a relatively quiet summer for U.S. stocks, which had touched new highs in mid-August. But despite Friday's jarring downdraft, market internals remain solid and equity markets are within stones throw of their recent peaks. Of course, the press reports are describing it as a full-blown market panic.

Even if the short-term pullback in stocks persists, we do not believe the longer-term bull market—which has been underway since 2009—is dead. U.S. economic data has generally shown signs of strength, and an improving economy should support the stock market over the long term.

So what’s going on?  Efforts to trace the reason why quick-twitch traders scattered for the hills on Friday turned up two suspects.  The first was Boston Federal Reserve President Eric Rosengren, who sits at the table of Fed policy makers who decide when (and how much) to raise the Federal Funds rate.  On Friday, he announced that there was a “reasonable case” for raising interest rates in the U.S. economy.  According to a number of observers, traders had previously believed there was a 12% chance of a September rate hike by the Fed; now, they think there’s a 24% chance that the rates will go up after the Fed’s September 21-22 meeting. Oh the horror of a less than 1 in 4 chance of a quarter-point (0.25%) rise in short-term interest rates--sell everything!

If the Fed decides the economy is healthy enough to sustain another rise in interest rates—from rates that are still at historic lows—why would that be bad for stocks?  Any rise in bond rates would make bond investments more attractive compared with stocks, and therefore might entice some investors to sell stocks and buy bonds.  However, with dividends from the S&P 500 stocks averaging 2.09%, compared with a 1.67% yield from 10-year Treasury bonds, this might not be a money-making trade.

If the possibility of a 0.25% rise in short-term interest rates doesn’t send you into a panic, maybe a pronouncement by bond guru Jeffrey Gundlach, of DoubleLine Capital Management, will make you quiver.  Gundlach’s exact words, which are said to have helped send Friday’s markets into a tailspin, were: “Interest rates have bottomed.  They may not rise in the near term as I’ve talked about for years.  But I think it’s the beginning of something, and you’re supposed to be defensive.” My thoughts on this: pundits have been declaring the end of the bull market in bonds for many years and have been proven wrong time and time again. Statements like this are pretty worthless in my opinion. Could he be right? Sure, there's a 50/50 chance.

Short-term traders appear to have decided that Gundlach was telling them to retreat to the sidelines, and some have speculated that a small exodus caused automatic program trading—that is, money management algorithms that are programmed to sell stocks whenever they sense that there are others selling.  After the computers had taken the market down by 1%, human investors noticed and began selling as well.

Uncertainty about central bank policy outside the U.S. was another potential cause for Friday’s volatility. On Thursday, the European Central Bank opted for no new easing moves and Japanese bond yields have continued to rise. The two events have sent a message to markets that quantitative easing (bond buying and other monetary stimulus) may have lost some of its efficacy and will not continue indefinitely.

For seasoned investors, a 2% drop after a very long market calm simply means a return to normal volatility.  This is generally good news for investors, because volatility has historically provided more upside than downside, and because these occasional downdrafts provide a chance to add to your stock holdings at bargain prices. I've been telling clients all summer long to expect a volatile and rocky September and October. Does that make me smart? Nope, historically, periods of calm like we've seen are always followed by volatility. September and October tend to be more volatile than other months of the year.  Markets have been unusually calm this summer, and prolonged periods of low volatility can make markets susceptible to news and rumors. Given the emphasis the market is now placing on Fed policy—and the uncertainty surrounding it—we wouldn’t be surprised to see markets continue to experience volatile swings when news or economic data suggest the Fed may, or may not, raise interest rates.

That doesn’t, of course, mean that we know what will happen when the exchanges open back up on Monday, or whether the trend will be up or down next week or for the remainder of the month.  Nor do we know whether the Fed will raise rates in late September, or how THAT will affect the market.

As for bonds, while rising interest rates can translate into falling bond prices—bond yields typically move inversely to bond prices—it’s important to remember that yields generally don’t move in tandem all along the yield curve. The Fed influences short-term interest rates, but long-term interest rates are generally affected by other factors, such as economic growth and inflation expectations. And even if the Fed does raise short-term interest rates again this year, I would anticipate that future rate hikes would be gradual, as inflation remains low and the U.S. economy is only growing moderately.

That said, periods of market volatility are a good time to review your risk tolerance and make sure your portfolio is aligned with your time horizon and investing goals. A well-diversified portfolio, with a mix of stocks, bonds and cash allocated appropriately based on your goals and risk tolerance, can help you weather periods of market turbulence.

All we can say with certainty is that there have been quite a number of temporary panics during the bull market that started in March 2009, and selling out at any of them would have been a mistake.  You must resist overreacting to swings in the market. Stock market fluctuations are a normal part of investing; panicking and pulling money out of the market may mean missing out on a potential rebound.

The U.S. economy is showing no sign of collapse, job creation is stable and a rise in interest rates from near-negative levels would probably be good for long-term economic growth.  The Institute for Supply Management survey for the manufacturing sector recently showed an unexpected decline, and the service sector moved down by more than economists had expected, so I will be monitoring upcoming survey results closely to see if this develops into a trend. The employment situation remains firm; new job openings hit a record high in July and new claims for unemployment remain near recent lows.

While it may be prudent to trim some profits, panic is seldom a good recipe for making money in the markets, and our best guess is that Friday will prove to have been no exception. Market volatility is unnerving, but it’s a normal—and normally short-lived—part of investing. If you’ve built a solid financial plan and a well-diversified portfolio, it’s best to ignore the noise and focus on your long-term goals.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Sources:

http://www.bloomberg.com/news/articles/2016-09-08/gundlach-says-it-s-time-to-get-defensive-as-rates-may-rise

http://www.forbes.com/sites/laurengensler/2016/09/09/stocks-fall-worst-day-since-brexit/#3a9ed7252961

http://www.bloomberg.com/news/articles/2016-09-09/split-among-fed-officials-leaves-september-rate-outlook-murky?utm_content=markets&utm

http://thereformedbroker.com/2016/09/09/dow-decline-signals-end-of-western-civilization/?utm

https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield

The MoneyGeek thanks guest writer Bob Veres for his contribution to this post

Did You Exit After Brexit?

The pundits had it all wrong with the Brexit vote (I too was wrong on the British vote to exit from the European Union).

With the benefit of hindsight, we can see that it would have been a bad idea to sell your stock holdings after the Brexit vote; you would have locked in a 5% to 10% loss in a market that has trended upward to new record highs.  The same is true of the aftermath of the World Court decision that slapped China in the face by declaring that man-made islands don’t transform an ocean into territorial waters, the attempted coup in Turkey, or, really, any other alarming headline which doesn’t materially affect a company’s ability to run its operations or earn a profit.

But the bigger issue is that, even if you knew the outcome of the vote, you still wouldn't have known how markets were going to react.  How would you know whether quick-twitch traders would buy or sell the event?  After the Brexit vote, it took a weekend for investors and traders to realize that this was Britain’s problem, not theirs.  Realistically, it could have taken a month, or even a year to play out.

The same is true for the time period that we’re heading into now.  As you can see from the accompanying chart, the average return for various months of the year has been pretty much the same across the spectrum.  But August, September and October have seen bigger highs and (most alarmingly) also deeper lows, on average, than other months.  This additional volatility seems to be random, and is, once again, impossible to time.  People who decide to side-step the late summer and early fall would miss out on average yearly gains for September and October of 1.05% and 1.21%.  (Skipping August would have saved you modest losses of less than 1%, on average, but one suspects that this is a statistical anomaly.) The month of August in election years, even during the bear market of 2008, tends to have a positive bias; will this year be one of them?

Finally, biggest picture of all, the current bull market, which started March 9, 2009, has now become the second-longest bull market on record, beating the June 1949 to August 1956 rally.  It is second only to the December 1987 to March 2000 advance.  In terms of percentage change, we are experiencing the fourth strongest bull market on record.

Doesn’t that mean it’s time to take our chips off the table?  If we knew how to consistently time the market, if we could be sure that the market run won’t continue to run up for another few years, then the answer would be yes.  But with the economy continuing to churn out positive gross domestic product (GDP--the measure of our output of goods and services), with inflation low and unemployment continuing to fall, and central bankers supplying liquidity and stimulus to the markets, it’s hard to see what would cause U.S. stocks to be less valuable in the near future than they are today.

Meanwhile, once again, even if we did exit, how would we know when to get back in?  Investors who bailed during the 2008 downturn missed much of the surprise upturn that began this current bull run.  Those who hung on more than made up for their losses, even though it seemed like every year would be the bull market’s last. One thing that I've learned from doing this for so long, is that moves in the market (in both directions) usually go on far longer than most people can imagine.

There isn't a day where some market "expert" or pundit comes out and says he likes nothing in this market and to sell everything? ... Really?? Sell everything?! It angers me how reckless these statements are. Giving blanket advice to people is irresponsible. You don’t know the person’s goals, age, risk tolerance, time-frame, etc. But fearful headlines will always attract eyeballs, and most of these pundits have something to sell you. Don't buy it. Maybe you should sell some things, but always do your own due diligence and always keep in mind your long-term goals.

It’s nearly certain that there will be a lot of scary headlines between now and the end of the year, and it’s quite likely that the investment roller coaster is about to get bumpy.  All of us wish that we had a working crystal ball to help us navigate through uncertainty, but all we have is the historical record, which says that after the next downturn, the market will eventually experience a new high (yes, this will happen regardless of who becomes our next president).  We want to be there to celebrate it.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Sources: 

https://www.washingtonpost.com/business/get-there/given-the-brexit-brouhaha-how-did-your-investments-hold-up/2016/07/22/a7bc1198-4d03-11e6-a7d8-13d06b37f256_story.html

http://www.investmentnews.com/article/20160801/FREE/160809992/if-history-is-a-guide-market-volatility-is-about-to-spike

http://www.cnbc.com/2016/07/13/merrill-second-longest-bull-market-ever-has-further-to-run.html

The MoneyGeek thanks guest writer Bob Veres for his contribution to this post