Stephen: The S&P 500 posted its worst first half in over 50 years, the US aggregate bond index had its worst first half loss in history, inflation is at the highest level since the 1980s and consumer confidence is at all time lows. But let’s take a step back for a minute, because we know it’s not all bad news. The sky’s not falling.
Thanks for tuning into another episode of the Smart Money Show. I’m your host, Stephen Rischall along with my business partner, David Jacobs. Let’s dive right in, David, bring us up to speed. What has gone on so far this year? Where are we at today with markets and the economy?
David: Well, the first six months have been very, very disappointing. There’s no question about it. Inflation is at record highs, at least in the last 40 years, interest rates have spiked, Russia invaded Ukraine, which none of us really thought would actually happen, and it has happened.
But, if we go back to the beginning of the year, when we did this video, our annual client outlook, we did expect lower returns after the last 12, 13 years of a bull market. And, we expected higher volatility. In fact, we called our talk, investors should focus on profits not stories, stories meaning cryptocurrencies or technologies that get a lot of attention and a lot of investment.
But, at the end of the day, it’s really profits that matter. And, little did we know how right we were gonna be. If we look at the returns through the first half of the year, the S&P 500 is in bear market territory, down over 20%. The tech heavy NASDAQ, the more risky, maybe more stories, not as many profits, down almost 30%, and higher quality dividend paying stocks, financials, energy, consumer staples, down about 12%.
Overseas fared slightly better than the US market, down 19%. It’s worth noting that overseas are really more dividend paying value type stocks, but currency really affected overseas stocks as the dollar really surged. We do here at Navalign, we have an overweight to value and international, but it only helps slightly on the downside, ’cause there was really just nowhere to hide in equities, outside of energy.
One of the things that investors really aren’t talking about much, but is really even probably a bigger story is bonds. Bonds are down over 10% for the year thanks to surging interest rates, the worst period in 40 years. Fortunately, about a year and a half ago, early 2021, we eliminated most of our exposure to interest rate sensitive bonds. So, much shorter bonds, some alternative investment bonds. So, our bonds, I’m happy to report, fell only about half as much as the actual bond market itself.
Stephen: Yeah, and you know what I thought was really unusual, David, is that here we are, in a period of time where both bonds and stocks, in concert, were down. That’s really unusual. I looked back at the charts and that hasn’t really happened since, well, the COVID pandemic, the financial crisis, and it happened shortly after 9/11.
So why did this happen? What do you think?
David: Yeah, well, there’s a few things. One, bonds usually buoy stocks when stocks are falling in vice versa. So, it’s very, very unusual, in fact, somewhat historic. And, I think it’s important to note it’s temporary.
But, if we go back in time to kind of see how we got here, following the financial crisis, we had a bull market for 10, 12 years. The pandemic hit, which was very, very surprising. And, we had kind of expected, I remember in 2019, doing a rebalance for all clients, saying we have to be at the late stage of this cycle. And, then the pandemic hit surprisingly, the market crashes in 2020. Everyone freaked out. We’re all staying at home, wearing masks, etcetera.
Well, the government’s response was to print, not just our government, but governments across the world, print outrageous amounts of money to help stimulate the economy. And, that did stimulate the economy. And, in 2021, we saw an opportunity for governments to start raising rates in the face of this inflation that we’re now dealing with. And, they really didn’t.
So, they kind of dropped the ball there. And, now, in 2022, here we are. They’re trying to make up for lost time by raising rates significantly to try and slow down this economic wildfire. Keep in mind that higher interest rates increase the cost of borrowing, whether it’s credit cards or mortgages. It puts pressure on valuations. So, we see the PE ratio on the stock market has fallen significantly as investors have de-risked, as we suggested they might. And, it just generally disincentivizes spending, because now you can save money in the bank and actually earn a little bit, as opposed to going to spend money out in the economy.
Stephen: Yeah, you know, I wanted to go back for a moment though, David, to inflation. Because, certainly, everybody’s feeling it in their pocketbook this year. We just got the reading, the numbers, the other day from the Bureau of Labor Statistics for the consumer price index.
Remember, that’s a backwards looking number over the last 12 months. So, we just got the June number and looking back over the last 12 months, it’s up 9.1%, which is a very, very big increase.
David: It is. And, it’s really important to notice looking backwards, so we had no inflation when the pandemic kicked, ’cause we weren’t spending any money, right? So, 2021 was looking back at 2020, and now 2022, we’re looking back at 2021. And, if you look specifically at energy in this chart, which is the green area, it’s up over 40% in the last 12 months, food is up over 10%. This is really the highest increases we’ve seen since the late 70s, early 80s. There’s other areas that really make up this inflation like travel and housing, while and these are probably gonna be a little bit more resilient, ’cause we see energy prices and food prices have been falling a little bit in the last few months.
Stephen: Yeah, that’s for sure. I mean we’re seeing things like listing prices for homes. They’re getting cut 5% to 10% and more. Homes are taking longer to sell, but we’re not seeing any sort of housing crash coming. That doesn’t seem likely, but prices are adjusting lower.
For things like travel, like you said, I agree. I think that’s gonna be a lot more resilient. A lot of us, I’m included, are probably still planning our travel, all that lost time during the pandemic. And, we’re gonna wanna still go out there and do this travel and go to these restaurants. So, that might stick around a little bit longer.
On the flip side, like you mentioned, David, some of those components like oil and food, oil is down almost 20%, the price of crude, in the last 30 days, and global food prices have actually fallen for the third straight consecutive month in June. So, some of those components that really increased over the last 12 months, we’re already seeing clear signs that those are coming down. We just have to be a bit more patient as we keep our eye on inflation, because we know these things take time.
David: We’ve seen oil spike in the past. And, eventually, as these oil companies, Shell, and Exxon, and Mobile, they… They’re not gonna wanna spend $100 a barrel when their contracts expire. So, I do expect oil to be coming down quite a bit in the coming year. And, it moves very quickly like the stock market does, other things take a little bit longer like housing.
One of the things that you mentioned though, Stephen, which I think we should really focus on for a moment is consumer confidence. While inflation’s been weighing on people’s minds and people are worried about a recession, it’s really interesting and surprising to note that consumer confidence is at its lowest level in history. This consumer confidence index goes back to 1940. So, it includes World War II, it includes all sorts of calamities, and crashes, and recessions and people are feeling more pessimistic today than they’ve ever felt.
If you look at this chart, the blue dots note the peaks at the top, when people are feeling most confident, and the troughs at the bottom where people are feeling most negative, which is where we are right now. And, what’s interesting is, if you look historically at how the market has done, when people are most confident, and some of the interesting points are January, 2000, before the tech crash. January, 2007, before the financial crisis, February, 2020, before the pandemic, people were the most confident they’ve ever been and the market subsequently crashed.
So, the average return 12 months following a peak is only about 4%. And, then when people are feeling most pessimistic, like they are right now, the average return for the following 12 months is almost 25%. So, it’s a really interesting case study to show that humans do the wrong thing at the wrong time. And, well, the question now is will the market, in the next 12 months, return 25%. A lot of factors will determine that, but history does suggest things will start to turn back for the better.
Stephen: I mean, I hope it certainly does. We’ll have to wait and see what happens there. This really reminds me of a conversation that I was having recently with a client of mine. And, he said to me, he says, “that he knew he couldn’t time the market, and that he wasn’t trying to time the market”, he wasn’t gonna try to do this, “but if we felt like a recession might be coming, or we’re in one, and just things aren’t so great, what if we just sold now and bought back in a little bit later?”
My response was that simply to his point, he’s right, that we can’t time markets. It’s a random sequence of returns. And, we have to remember that, even during tough times in the market, we still have good days.
This got me thinking, I wanted to know what would happen if you really just missed a few of those good days more recently through the COVID pandemic and recovery, what would’ve happened if you just missed the five best days during that period of time compared to staying invested?
Here on the chart, we put this together. This is literally through just before COVID up until the end of June here. If you just stayed invested for that three year period, over the last three years, you’d be up 35%. But, if you just missed the five best days of the market, you would have a negative return of 6%. And, if you missed the 10 best days, you’d still be down over 23%. So, you really would’ve blown benefiting from that recovery.
David: That’s pretty incredible. But, I can’t imagine that most investors would only miss the worst five days or the worst 10 days, ’cause they usually don’t happen consecutively, right?
Stephen: Right, that’s true. Although, some of these days are actually really close to one another during the recovery, in terms of the best days. So, we looked at this another way, because I thought the same thing, and I was like, okay, well, let’s say you were an investor and you sold, right? And, good luck with your market timing on selling, but then you gotta be right twice, right? We’ve said that before. You gotta be right on when you buy back in too.
So, what happens if you were late on buying back into the market here from the COVID pandemic at the bottom? So, the bottom was on March 23rd of 2020. And, we see that if you happen to have the perfect timing and you bought on March 23rd I mean, congratulations, first of all, go to Vegas, but you’re up 74.9%, up until June 30th. If you were one month late, just one month, you missed that first month, you still did well, but you’re only up 39%. If you were six months late, that’s 24%. And, if you were still waiting on the sidelines for a whole year after March 23rd, 2020, you would actually still have a negative return.
Pretty remarkable. I think again, the moral of the story here is you gotta stick with your investment plan for the long term, through the good times, and through the bad times. Clearly, like we said, David, the first half of 2022, it’s been challenging in a lot of ways. What do we have our eyes on next through the rest of this year?
David Good question. So, our outlook for the rest of the year is that most of the economic momentum that we had had going through the beginning of this year has slowed. There’s already forces gathering that’s slowing us down. We may already be in a recession. The government stopped printing money. There’s no more stimulus. The housing market is softening thanks to increased supply, reduced demand, because of the cost of mortgages. The dollar is soaring. So, our goods and services globally are a lot less attractive.
We just went through how consumer confidence is at an all time low, consumer spending is over two thirds of our economy, and if we’re all feeling a little more negative about spending, that’s gonna affect our economy quite a bit. And, then we’re possibly in a recession. Recessions are backwards looking. They’re not always the financial crisis or tech crash. Some recessions are healthy.
In terms of our outlook on the stock market, despite our expectation of continued volatility, and not really knowing where the bottom is, when things are falling, they can continue to do so. And, it is very, very scary. And, the economic challenges that have already discussed, we’re optimistic at this point on the long term environment for stocks, for a few reasons.
One, consumers and corporations have very, very strong balance sheets still. Unlike the financial crisis, consumers have large bank accounts even though the market’s down, their portfolios are still worth more than they were in a long, long time. And, corporations have very, very strong balance sheets too, again, unlike 2007, 2008. The labor market’s very strong. For every unemployed person, there’s two job openings, almost two job openings. And, while we expect labor markets to start to tighten and job openings to start to retreat a little bit, it’s still extremely strong for what might be a recession.
Secondly, earnings are likely to be the key driver of stock performance going forward and earnings while expected to be lower this year in terms of the growth, we do expect positive earnings growth, not PE expansion, which really fueled the stock market the last few years. PE expansion, of course, is people are willing to pay more for a dollar of earnings that that’s when they start getting pretty risky. So, the PE ratio on the market is now around average. It could obviously go lower, but we think that that will be a real focus and that’s a welcome return to fundamentals.
We’re likely gonna be either in or entering what we would call a healthy recession, which is a shallow recession. That’s kind of a reset in the last 10, 12 years just to kind of get a lot of that excess out of our system. And, most importantly, when it comes to stocks, the stock market looks forward and there’s a lot of positive headlines on the horizon, specifically the end of the Ukraine, Russia conflict. That will happen at some point. That will be a huge win for our sentiment.
Inflation, while it’s peaking now, and has some signs of slowing, it will eventually start to retreat. Again, it might take six months to a year, when we’re looking back at 2022, but inflation will start to wane most likely. That will be a very big positive.
Interest rates are gonna stabilize. They’ve gone up a lot. They’ll likely continue to go up a little bit. The fed is likely to overshoot, and raise too high, and start to ease interest rates in the next year or two. But, as interest rates start to stabilize and come down, that will be a big plus. And, probably, the most important, is we’re gonna eventually go into recession and emerge from it. And, as that positive outlook starts to hit our consumer confidence, we’ll all feel good. And, our risk appetites will return.
Stephen: Yeah, I agree with you David, and, look, I mean experiencing volatility in our portfolios, the barrage of all this negative news in the media, we get it. It can really take a toll on an investor’s psyche. As professional investors, when we read some of these shocking headlines and listen to the news, it affects us too.
We get it. So, just remember, we’re here for you. If you have questions about your portfolio, more importantly, your financial plan, and how it aligns with your investment plan, and, hey, if it’s been a little while, and you want to touch base, and have a review, let’s make time to connect. Let’s make time to chat, ’cause we’re here for you.
If you learned something new, if you found this video interesting or helpful, please feel free to share with your loved ones, friends, and family, because they might be thinking some of the same things that you are too. Until next time, I’m Stephen Rischall. That’s my partner, David Jacobs. And, this is the Smart Money Show.