Here are three key thoughts to consider as the market goes through its current cleansing cycle.
IF YOU ARE PREPARED, YOU SHALL NOT FEAR. You’ve heard this from us many times in the past. This means you need to control your expectations in all things. Especially money
Next, there are two general investment styles. “Strategic Investing” is being on the market roller-coaster. This method has historically been the best way to make the most money. But it’s also the most volatile with its euphoric highs to its hopeless depression of capitulation where you want to be in cash and never invest again. Think of an average of 12%, plus or minus 30% or more. “Tactical Investing” is Defensive, less volatile, and at times not as satisfying. Think 5 to 8% average results, give or take about 10%. Tactical money managers follow their exclusive computer algorithms to sell out of equities after they have reached a high, and will then move some or all of the asset into cautious money markets or bonds. When they feel it is the right time they will check the financial forecast before getting back in.
Finally, you’ve heard us talk about the Greed versus Fear market driver many times before. In fact, a year ago I warned about this very issue in the blog regarding our present historical Bond Inversion. Greed can be both the desire to get more of something, or to covet and hoard what you have. The fear of losing your money is just as strong as the fear of not having more.
Review our blogs on this topic for the past two years, specifically in April 2024, and then in December and May of 2023. We’ve been expecting these major changes for some time.
BACKGROUND ON OUR CURRENT ECONOMIC POSITION – written last week:
It’s the first of August, 2024, and all of a sudden, people aren’t so certain about how well the economy is doing. In just a few days the economic mood went from exultant to gloom as U.S. Federal Reserve Chairman Jerome Powell gave the news the market was expecting with decreasing interest rates finally on the table for the next Fed meeting in September, assuming continued decreasing inflation. Then the major indexes all took a nosedive as unemployment numbers jumped up.
Just a week ago the tenor of the economy seemed reminiscent of Fed Chair Alan Greenspan’s 1996 exclamation that the dot-com bubbled stock market was rushing uncontrollably upward. The LA Times reported Chairman Greenspan “warned that ‘irrational exuberance’ in financial markets could drive stock and bond prices to unrealistic levels and trigger a collapse.” This comment, the LA Times said, resulted in a “nose-dive” of the stock market.
This blog will take a brief review of the long-term market trends, and then provide some unique observations and potential outcomes.
The S&P 500 During My Lifetime
One of the most often used indexes, the S&P 500, began nearly 70 years ago on March 17, 1955. I was six months old.
The following graph shows the ten past recessions, each resulting in a volatile economic period. The blue dotted line shows the Logarithmic Trendline, whereas the red line is the Exponential Trendline. The market will follow a trendline, meaning when it moves higher than the line, it will usually retreat to that line, or sometimes below it to find an equilibrium. If either of these lines represent a potential return to stasis, you should not be surprised to see the S&P 500 in the future drop 30 to 50%. I’m hopeful the upcoming recession -- whenever it is -- will be in the moderate 20 to 30% level, but I’m emotionally prepared for a more volatile time.
Since the Federal Reserve increased interest rates, it has been intriguing to hear everyone’s reasoning for why the Fed interest rates should come back down. It has very little to do with the level of inflation. That seems it was almost a diversionary tactic for Chairman Powell to discuss inflation as the future reason to decrease the interest rates, whereas we really know there are some major economic issues boiling on hold out on the horizon. My December 2023 blog discussed the need for an interest rate at today’s 4 to 5 percent Fed Rate level. This idea is supported by the following chart.
Here are some financial planning concepts gleaned from the following information:
- Column B is the number of months it took for the Federal Interest rates to move from high to low, and Column C is the decrease of the interest rate during those months, which correlated to the correction of a floundering economy due to a financial problem or a recession.
- Columns E (the number of months) and F (the decrease of the Fed Interest Rate) show time period and the “gunpowder” the Fed must keep dry to help the economy stay healthy.
- In other words, as a recession or other economic difficulty rears up, investors yank their stock positions and move to expected safety in the bond market. That increases the values of bonds but decreases the interest rates. For example, from 1980 to 1983 the interest rate plummeted nearly a cumulative of 24% while the Federal Reserve decreased the Fed Rate only by 8.5%. To offset the volatile interest the Fed had to also raise the Fed Rate numerous times.
- During the “Great Recession” of 2007 to 2009 the Fed decreased the Rate by 5%, and the interest rate offered to banks was as low as 5/100th of a percent. Almost zero.
- Even though the Fed was slowly increasing the interest rates by 2019, the short-lived government induced recession caused by the COVID Pandemic once more brought the Fed Rate back down near zero.
- The Federal Reserve governors voted to increase the Rate to 5.25 to 5.50% because they had to have some room to work in case another recession required more decreasing interest rates to give the economy a boost.
- Recessions seem to come in the short term version of under one year (about 70% of the time), and then the long drawn out versions of one to two years (the other 30% of the time).
- About 60% of the time the short-term recessions get to work very quickly to offset the nose-dive – the biggest drop in the market -- happening in the first one to three months. Then 40% of the time these recessions see the rates starting to come back up after about 8 to nine months.
- The Long-Term Recessions (fewer, but bigger) see the rates drop quickly, stay flat or slowly move up during the next year with another big drop in the last part of the second year. This is what happened in 2008.
- Only once in 70 years, out of 14 interest rate decreases, did the Federal Reserve reduce the Interest Rate with a significant drop of 1.50% or more to prop up the economy, to decrease inflation of unemployment, to avoid a recession.
- Three out of 14 times (21% of the time) the Interest Rates dropped on their own without a recession or the Fed stepping in to manipulate the rates. This shows it is unusual for the Fed to drop rates to make everyone happy with lower inflation, etc. The Fed needs a sizeable level of interest rates stored up to use it in case things get really worrisome.
A SHAKESPEARIAN ASIDE:
MAKING EFFECTIVE DECISIONS WITH LIMITED INFORMATION
As I have studied financial analysts, the media, and what the four Federal Reserve Chairmen have said during the past 30 plus years, I have noticed a disconnect. From my experience, I personally know the naivety, bias, and outright ignorance with which many reporters will approach their news assignment. Most information gatekeepers will either have some personal limitations, or they will be controlled by their media management to rush through a story, as they only have so much time in a work day, often due to the immense amount of information. Reporters may be directed to follow the management philosophy which has its own predetermined bias due to the marketing decision of the potential advertising audience. Occasionally, even the government employee watching over their shoulder to make sure that their position and retirement is not negatively affected will paint a self supporting picture. The bottom line is we attempt to listen to everyone to make a reasonable middle-of-the-road decision. Making your decision based on one source alone will never provide a big enough picture to proceed with any confidence. Wisdom requires looking at both sides of an issue, financial, political, personal, or otherwise.
Now, back to finances:
FINANCIAL OBSERVATIONS AND GENERAL CONCLUSIONS (AS OF TODAY)
A Recession is coming!
While you may say, “Of course,” a large number of investors prefer to be pedal-to-the-metal even when they know they are not 20 years old any longer and should be acting their age. If you have ten or more years in the workforce left, you can be aggressive (an 80/20 or 70/30 stock to bond ratio) because history shows you will probably see your investments turn positive even with a big downturn in the market. But when you are coming up on, or are in retirement, depending on your situation, you need to be cautious and more moderate (a 30/70 to 60/40 stock to bond ratio).
Here are some points to consider, and expected happenings coming up in the future:
- Strategic and Tactical investing needs to be weighted depending on the number of years planned to be in the workforce.
- The Inverted Treasury Bond Market points to a Recession being announced in the near future. The more investors run to safety, the more the rates will decrease. The Fed Governors will be able to give a brief boost to the stock market as they decrease the interest rates. They will need to be cautious not to over-react as they can push the bond interest rates right back down to zero.
- Unemployment is expected to go back up, causing the Fed to act even further.
- Inflation will return, and the Biden Administration will not be able to decrease the Federal Gas Reserve forever. That’s what has been keeping the price of gasoline down during the past few months, which in turn, brings inflation down.
- In March 2024 Chairman Powell warned “small to regional” banks are expected to fail, which is code that he would need the flexibility of decreasing the Interest Rate. Powell said the reason for the failures will be bankruptcies among Commercial Real Estate loans held at the smaller banks.
- Geo-political issues of country retaliating against country will cause even further stress on the worldwide markets.
Last week, two stories of note:
From CNBC: “If the Federal Reserve is starting to set the table for interest rate reductions, some parts of the market are getting impatient for dinner to be served.
“What is it they’re looking for?” Claudia Sahm, chief economist at New Century Advisors, said on CNBC just after the Fed concluded its meeting Wednesday. “The bar is getting set pretty high and that really doesn’t make a lot of sense. The Fed needs to start that process back gradually to normal, which means gradually reducing interest rates.”
Finally, with all the positive financial news, Barrons, early last week, wrote this warning:
“[Artificial Intelligence] like the internet in the early 2000s, presents new sales and profit opportunities for both Big Tech and the smaller players. Tech’s heavy weighting in the S&P 500’s market value has pulled the benchmark index up 52% since its October 2022 low.
“But the differences between now and then are a lot…. [While the NASDAQ looks very similar to the dot-com bubble, the companies are in a much better position.]
“No, that’s not the real worry. The S&P 500 is. It smacks of 2007 all over again. From last July until now, the index has traded with an 85% correlation to July 2006 though July 2007, according to Sevens Report’s Tom Essaye.
“The S&P 500’s movement in the past year is scarily similar to that time almost 20 years ago. The index climbed, stumbled, rose again to record highs, and then tumbled. Right now, the S&P 500 is down from its July 16 record high….
“No, nobody is forecasting an all-out economic collapse—even the experts rarely see one coming. But, yes, the economy does look vulnerable to recession.”
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In conclusion, I say, as I began: “If you are prepared, you shall not fear.” The majority of our clients have worked closely with us preparing for such a time as this. If you are worried about your investments, please feel free to contact us. That’s what we are here for. If the person you are calling is not available, you can talk with Erik, Daniel, or Carlee. They can answer your specific questions.
References:
https://www.latimes.com/archives/la-xpm-1996-12-07-mn-6671-story.html
The Stock Market Doesn’t Look Like the Dot-Com Bubble. It’s Something Worse. https://www.msn.com/en-us/money/markets/the-stock-market-doesn-t-look-like-the-dot-com-bubble-it-s-something-worse/ar-BB1qYgAT?ocid=finance-verthp-feeds