Charles Dickens’ classic novel Great Expectations is a coming-of-age tale of a young man, Pip, who unexpectedly receives a large fortune and his ambitions to rise to a higher social class. Throughout the story Pip desires to improve his life and this belief in the possibility of advancement provides great expectations for his future. He learns that as his life improves it is not always more satisfying. Closer to home, last week’s winter storm did not meet forecasted expectations of being a historical meteorological event, despite receiving what otherwise would be considered a decent amount of snow. What if forecasters had instead predicted an amount of snowfall that was much less than what was received? Given the amount of snow we did receive, would this storm have then been viewed as being more impactful? Perspective is dependent upon expectations and reasonable expectations tend to lead to better outcomes, especially when it comes to the markets. Did the bull market of the past decade alter reasonable expectations of how markets might perform in the future?
To provide a historical perspective, the price return (not including dividends) of the S&P 500 has averaged 8.7% per year going back to 1958, when the index was expanded from 93 to 500 stocks. An 8% return for the stock market is frequently used when doing very rudimentary financial planning assumptions, but the S&P 500 has experienced a positive return between 6 and 10% during a calendar year only six times in the past 95 years. This demonstrates how annual market returns are much more volatile than the average and based on historical probabilities, chances are very high of experiencing returns in any calendar year that are significantly different than 8%. Also, do not overlook the sequence of returns risk, where the assumed average returns might be as expected over the long term, but the order and timing of investment returns can have a big impact on how long your retirement savings last.
Looking back at the not-to-distant past, during the “Lost Decade” of the 2000s the S&P 500 was nearly flat for ten years, losing an average of 0.6% per year. This includes four years of double-digit losses and three years of double-digit gains, both averaging more than 20% in their respective directions. But looking out further, the S&P 500 has nearly tripled since the end of 1999.
A Tale of Two Cities
Another classic novel written by Dickens was A Tale of Two Cities” which underscored the differences between London and Paris during the 1780s; a time when England was relatively peaceful and prosperous while France was experiencing upheaval in the events leading to the French Revolution. In terms of differences, there has been much talk recently about conflicting expectations between investors and signaling from the Federal Reserve when it comes to the path of interest rates. Much of the strength in the markets during January was attributed to expectations the Fed might “pivot” later this year and begin to cut interest rates, contradicting the Fed’s view that they need to continue pushing interest rates higher to fight inflation. The last couple of weeks have proven to be a time of reckoning for the markets, largely due to the latest inflation reports. Last week the Personal Consumption Expenditures (PCE) came in higher than expected with the core rate moving higher for the first time since last September, further dampening the disinflation narrative. The gap between market expectations for the path of interest rates and the Fed’s outlook has been narrowing with markets seemingly accepting that rates are going to stay higher for longer. This resulted in the major stock indices suffering their third consecutive week of losses.
We can use history as a guide when it comes to market expectations, but as any investment professional will tell you, “past performance is no guarantee of future results.” Stock market performance has been robust with average annual returns in the double digits over three out of the last four decades, with the 2000s being the sole outlier. The environment we are experiencing today is different than what has been experienced in the past. Technological innovation continues to provide what we view as outstanding investment opportunities and information can be disseminated almost instantaneously to a wide audience, making this the best of times. But wages are not keeping pace with inflation and higher interest rates are leading to higher borrowing costs, impeding economic growth, making this the worst of times, at least in recent memory, for many people. Higher input costs and slowed spending are affecting the bottom line for many companies, leading to negative earnings growth. These headwinds for the market are not likely to dissipate quickly and we do not expect the next several years to be as prosperous for stock investors as the last decade was. However, we still strongly believe that over the long-term, wisely investing in the stock market remains the best strategy for building wealth and maintaining purchasing power of your hard-earned savings.
Earnings season is largely winding down with a few notable retailers set to report this week, including Target, Lowe’s, and Costco. These earnings reports are likely to show consumer spending remains resilient, but shoppers seem to be more price conscious, pressuring bottom line profitability. A slew of speeches from Federal Reserve officials are also scheduled and while their comments might garner a great deal of attention, they won’t mean much until the next Fed meeting at the end of the month. Since inflation remains persistent, interest rate increases are expected to continue with current expectations for three more quarter-point interest rate hikes this year; one at each of the three meetings. In light of recent inflation reports coming in hotter than expected, some Fed officials have publicly stated they may favor a half-point increase at their next meeting in late March. The anticipated peak in interest rates for this Fed tightening cycle continues to move higher and is now 60 basis points (0.60%) above where it was just a month ago.
We frequently discuss the importance of maintaining a long-term perspective on the markets and caution against focusing on short-term moves. This was perhaps well captured in Berkshire Hathaway’s most recent annual letter, in which Warren Buffett stated that he and long-time partner Charlie Munger, “…firmly believe that near-term economic and market forecasts are worse than useless.” Also of interest in the letter was Buffett reflecting on his many decades of investing. He admitted most of his capital-allocation (investment) decisions have been no better than so-so and there have been some bad moves. He goes on to say, “Our satisfactory results have been the product of about a dozen truly good decisions and a sometimes-forgotten advantage that favors long-term investors…” In other words, he is saying not all investment moves will be successful but remaining patiently invested in the markets and maintaining a long-term perspective leads to success. If you would like to discuss your situation and ensure the expectations you have for your retirement remain reasonable please do not hesitate to contact us.
Have a wonderful week!
Nathan Zeller, CFA, CFP®
Chief Investment Strategist
Please contact us if you would like to review your individual financial plan or learn how the TaxSmart™ Retirement Program can help you.
Office phone # 952-460-3260