Markets

The 17th bear market since the end of World War II has arrived. We offer a few thoughts to help give it some perspective… but first, here are “the numbers:”

The first six months of 2022 saw the S&P500 stock index of the 500 largest American-traded companies decline 23.6% from its all-time high of 4,796 on January 3, to a closing low (so far) of 3,667 on June 16. The Index finished its worst first half year since 1970.

In mid-June, the market ran off a streak of five out of seven trading days on which 90% of the S&P500 component stocks closed lower. This is one-sided negativity on a historic scale.

16 Bear Markets since WWII

To put the present bear market into context, let’s look at the 16 previous bear markets since the end of World War II (a “bear market” being defined as the S&P500 closing around 20% or more below its previous all-time high). They tell us that as long-term stock investors, every 5 years or so we can expect a (temporary) drop in market price averaging ~34% lasting an average of 15 months (with a wide range from 1 mo to 5 yr). So, although it may not feel that way, the present bear market is a perfectly normal part of successful goal-oriented stock investing.

More importantly, if we look at the peak of the S&P500 just after the end of WW II and compare it with present peak made this past Jan. 3, 2022, we see that the index has risen over 200 times in price. Furthermore, if dividends were reinvested, the total return goes to over 2000 times! This impressive growth through 16 bear-market cycles occurred despite:

• Four Major Wars (Korea, Vietnam, Iraq, and Afghanistan)
• The nuclear “Cold War”
• The Stagflation of the 70s
• The 2000s Great Recession
• Plus many political, racial, ecological, and other crises du jour.

How has the “average” investor done over the long-term?

Fortunately, Dalbar statistics has tracked this over 30 year time frames (a time of interest since it’s the length of the typical 2-person retirement). Over the past 30 years, the average investor, including those with advisors, has received an average annualized return (with dividends reinvested) of about 5%. On the other hand, over the past 30 years, the S&P500 market index has had an annualized return (with reinvested dividends) of about 10% (a rate of rise that is also consistent with the 75-year results in the chart above). That is, the average investor got only half of what the market would have given them if they had simply stayed in the market. Half!

Why? Human nature – It’s easy to react to current events and get out of the market. It feels good. But then the average investor and their advisors have created a bigger problem for themselves. When do we get back in? It feels scary. As one of the greatest investors of our time, Warren Buffet, recently remarked, “I have never met a man who could forecast the market.” No one. Most “timers” buy back in too late and miss the great rebounds that occur off bear-market bottoms. Since we, nor anyone else, can consistently time the market, by default we stay in the market.

All of which is to say that the best way to destroy any chance for lifetime investment success has historically been to sell one’s diversified equity portfolios in a bear market, especially when investor sentiment is sufficiently negative to sell when everyone else is selling.

Bear markets are not fun, but as goal-oriented investors we prepare for them, with enough cash reserves to cover several years of living expenses (so we do not have to sell in a down market if we need money). Historically, the great companies of the US and world have always found a way of making money in almost any situation. Individual companies will fail of course, but staying in a balanced, diversified portfolio has substantially exceeded inflation, by ~3 times (annualized return data back to 1870, Shiller).

70’s Stagflation “All Over Again?”

Which brings us to the present crisis du jour. Those who invested throughout the 70s will remember the “stagflation” of that time. Simply put, inflation is the result of excessive demand chasing inadequate supply. To restore balance between the two, prices go up.

Back in the 70s this imbalance developed from a number of factors: we were coming off the gold standard, OPEC created massive oil shortages, and the money supply had been greatly expanding since the mid-1960s to pay for the Vietnam war and a number of fiscal programs. By the end of the 70s, it looked like inflation was uncontrollable. Inflationary expectations were leading to excessive buying and stockpiling (buy while you can before prices go up further!), which led to a viscous feedback cycle — stagflation. Unemployment was at record highs. Finally, in mid-1979, Carter appointed Paul Volker to chair the Fed during the last 1.5 years of his presidency. Volker started severely tightening the money supply until inflation was brought back down early in Regan’s term. (One of the better summaries of this time had been written by B. Bernanke.)

In the present case, the situation is different in several significant ways. Inflationary expectations have not yet reached the 70s level. During the Covid shutdown, people greatly reduced spending, many received stimulus checks, and personal and corporate savings rates reached generational highs. Emerging from the shutdown, people are now finally able to get out and start spending again, and they’ve done so with gusto…. much more rapidly than manufacturers and service businesses can restart shut-down businesses. Restarting a business takes time, supplies, staff, and training. We suggest that the present inflation is primarily a result of an imbalance in recovery rates between spending and supply coming out of the worldwide Covid shutdown. Adding Putin’s War on top of that has exasperated supply shortages (among many other problems this war has brought).

So where are we now?

After a delayed start, the Fed is acting aggressively to slow spending and it has the tools and sufficient political independence to do so. But it generally takes about a year to change people’s spending habits. On the supply side, the situation will heal naturally because businesses eventually respond to increased buying. Forward earnings estimates for mainstream equities have continued to rise, despite the increase in interest rates and market drop. Unemployment is at record lows, with almost two job openings for everyone looking for work. We make no predictions, but this does not seem to have the makings of a decade-long timeframe of future stagflation.

The market, of course, will do what it needs to until it resumes its long-term upward trend, and we are prepared. We don’t focus on what we cannot control, but rather what we can. In that regard, some great opportunities are presenting themselves now.

Opportunities

With stock prices down, we have implemented several strategies for our clients during the first half of this year. Since we are focused on lifetime tax planning (among other things), some great opportunities during down markets are:

• Tax-loss harvesting into nearly equivalent securities (in taxable accounts)
• Strategic conversions into Roth retirement accounts for those in their Golden Window™ years between retirement and age 72 to lower their lifetime tax bill. (When prices are low, more shares can be converted to tax free Roth accounts for the same tax cost.)

It’s also an opportune time to take advantage of lower stock prices by:

• Rebalancing from fixed income (bonds) into stocks.
• Dollar-cost averaging into the market – Bear markets are opportunities for wage earners to get more shares for the same paycheck contributions.
• Putting available liquid funds to work while stocks are “on sale.”

From the standpoint of opportunities, we ? corrections.

Thank You!

 
For the second year in a row, Nest Egg has been voted best financial advisor in North Tahoe and Truckee for 2022! We appreciate your trust, confidence and continued support.

OCTOBER: This is one of the peculiarly dangerous months to speculate in stocks in. The others are July, January, September, April, November, May, March, June, December, August, and February.
                                                               –Mark Twain