A Few Logical Questions During a Time of Malaise
/A few logical questions during a time of malaise
Bear markets are defined as a 20% decline from a high-water mark in a security or index. I believe that a bear market is better defined by feelings of pessimism and fear. I would sum these feelings up with one word: malaise. By the ladder definition we have been feeling malaise since roughly February in financial markets. This feeling begs a few natural questions that I will offer opinion around.
When does the malaise end?
Many will guess and some will get lucky, appearing to be seers of future events (you can always test their accuracy by asking for past predictive accuracy). The point remains that no serious market participant knows for certain when this will end. We could be days, weeks, or months away from this point. I believe the key variable to break this market pessimism is the Fed (Federal Reserve). It won’t occur the day the Fed says or signals that they are done raising rates, the turn will occur before that in anticipation of said occurrence. Keep in mind, I believe the Fed is the key variable but not the only variable. There are a litany of additional variables that could change the market’s course thus making clean predictions around the course of a future market a risky endeavor. We will entirely avoid said endeavor.
What will it look like when the market turns?
Again, no serious market participant knows. We could have a rapid move higher if the Fed is able to pivot from increasing rates to holding or cutting rates while peace pervades in Ukraine and the US/world avoids damaging recessions. Consequently, we had a dry run of what the market would look like if there was a swift recovery. From a low on June 16th, we watch the S&P 500 rally back north of 17% in roughly a two-month period. This could be called a “V” shaped recovery given the shape created on a graph of a quick drop and quick recovery. This is one probable outcome while another, readers of my early piece “Fear of Flatness” know this outcome, is a choppy, directionless market. This outcome could already be showing as the afore mentioned rally has largely dissipated (as of this 9/22/22 writing) to leave us sitting near the mid-June lows. We must prepare for different potential recoveries from the lows in the market.
What should be done in these markets?
An absence of action can constitute a purposeful choice. Simply put, making huge changes in volatile times can often substitute short-term relief for slow, long-term pain. Not making moves is a decision in and of itself.
Having the confidence to believe we or anyone we follow can confidently call the bottom and subsequent invest accordingly is not the course we choose. Helping our clients maintain the best asset allocation for their given situation based on financial planning and the ability to absorb various market outcomes is the chosen path. There is a saying that “you are rewarded for time in the market not timing the market”.
We favor small, incremental changes based on high probability outcomes. For example, increasing portfolio exposure last year and the beginning of this year to dividend paying stocks can help ride through a down or choppy market because of the organic portfolio cash-flow created by these dividends. The investment saying here is “a bird in the hand is worth two in the bush”. In times of stress, you want to know what you are holding not what you are fantasying about holding.
Fine, I understand all of this, but is there any silver lining?
Yes, yes, a thousand times yes. Money now has a cost and that is, very probably, good for long-term economic health. Simply, if you or a company borrows funds to fuel a purchase or capital project, the project must now produce larger or more certain returns than it would have a year prior. This leads the market to cull weak capital investment ideas in favor of strong, sustainable projects.
Furthermore, savers are now rewarded exponentially more on a nominal basis than they were just twelve months ago. For example, if you had bought a 1-year treasury bond last September it would have yielded under 0.10%. Today a new 1-year treasury yields over 4.00% (as of 9/22/22). Over a 40x increase in yield. While this punishes borrowers and slows economic activity in the short-run, we are of the opinion that a more balanced cost of borrowing/reward for savings can act as a catalyst for the next, multi-year economic and equity market expansion.
To enjoy the wealth creating benefits of our free-market, capitalist system we must have periods of reset where weak, over leveraged borrowers are punished in the short-run and the strong, prudent capital allocators are rewarded in the long-run.
Final thoughts
Risk assets are on sale. If you accept the thesis about the in-ability to peg the bottom of the market, you can still rest assured that mathematically the average stock is anywhere from 10-30% lower than it started the year. If you look at the index level like the S&P 500, you are buying at a roughly 20% lower price than the start of the year. This doesn’t guarantee huge returns; however, historic precedence would indicate you have a higher probability of better future returns than had you purchased at the beginning of the year.
This year has not been fun nor rewarding in almost any asset market. Keep in mind that the decisions of today determine the returns of tomorrow. We keep today’s decisions, with high conviction, focused on the long-run, resisting short-term needs for catharsis, and take advantage of small, tactical moves for long-run success. This malaise too shall pass.
As always, I am available for questions, feedback, commentary, or just to chat by cell 248.982.8190 or email rob@ffadvisor.com. Be well and focus on the long-term!