Choose Your Own Adventure
When I was growing up, “Choose Your Own Adventure” books became popular. In these books the reader becomes the protagonist and makes choices which determine the final outcome. What I especially enjoyed is that after reaching one ending, I would return to a decision point, make a different choice and the story would have a different conclusion, providing various stories within the same book. Savers and investors also make decisions which ultimately affect their outcome but unfortunately in real life, you do not have the ability to go back and make a different decision in hopes of realizing a different result. What makes investors’ decisions complicated is that nobody knows for certain what the markets are going to bring in the future, so choices can only be made using the best information available.
Many investors tend to review past decisions and evaluate what they could have been done differently. Spending a reasonable, not excessive, amount of time doing so can be helpful for making future decisions since history tends to repeat itself and we can learn from our mistakes. History does repeat itself, but it is very rarely exactly the same. Right now, the major market headlines include inflation and rising interest rates with comparisons to conditions of the late 1970s and early 1980s. There are similarities between then and now, but there are also differences. For example, we have a stronger labor market today which is fueling higher wages and contributing to inflation. When not accompanied by high inflation, higher wages provide workers with the ability to increase their spending since they are receiving more pay. The concern is that “real” wage growth, which is the growth in wages adjusted for inflation, is currently negative so consumer spending will slow, leading to slower economic growth.
Speaking of the markets, April has come in like a lamb. This does not mean it has been quiet or lacked volatility, but rather it has not roared to new highs as if it were a lion. Last week the stock market retreated as more Federal Reserve officials indicated they expect interest rates to increase at a faster rate than previously expected due to inflationary pressures remaining elevated and possibility accelerating. Not surprisingly, these comments also caused bond yields, especially longer term, to move higher. In the past, interest rate increases have been a headwind to equity returns, which is what we have experienced so far this year; so in the short-term history does appear to be repeating itself.
There is always some uncertainty in the markets and economy, but there seems to be an abnormally higher amount now. The yield curve, which was inverted a week ago, has for the most part “uninverted” but remains flat. Recent movement in the yield curve has led some economists to predict a recession, but not until late this year or sometime in 2023. Higher costs and lower inflation-adjusted wages are likely to lead to less spending which would slow growth but will it pullback enough to cause negative growth, a.k.a. a recession?
There could also be a case made for deflation in the future, as spending slows and energy markets normalize. As a side note, another differentiator between now and 40 years ago is that the energy markets are substantially different but that is another topic unto itself. Only time will tell if we end up with higher inflation or deflation over the next year, but either way the outcome could be similar – a recession. There is a chance the Federal Reserve engineers a “soft landing” with inflation and interest rates where the market does continue on a strong bull run but that probability seems to be diminishing and lower than other possible outcomes.
The real question for investors is how this affects the markets and what choices need to be made. As for the bond market, higher interest rates, most likely much higher, seemingly continue to be on the horizon so bonds are probably not going to be a great place to be invested, at least for the next several months. As we discussed last week, most of the time the stock market retreats well in advance of a recession. And recessions are not always accompanied by bear markets. But current conditions seem to be pointing towards higher probabilities of a market decline than we have seen in many years.
As an investor you have the choice of taking your money out of the market, potentially missing out on opportunity with a rebound. On the other hand, if you remain fully invested and the market drops you will lose some of your hard-earned savings. Another option would be to reduce holdings and hold some cash. In gambler’s parlance, this is referred to as “taking some money off the table.” By remaining mostly invested you would be able to capture market gains should the market move upward but if it were to drop you would have cash available for a buying opportunity. Over the longer term, the stock market continues to hold a lot of potential especially for sectors such as healthcare and technology, which will continue to innovate and impact our lives. Much of the investing decisions made today should be dependent upon your individual tolerance for risk and shorter-term liquidity needs.
The upcoming week will bring numerous events with market-moving potential, especially the kick-off to Quarter 1 earnings season and the release of Consumer Price Index (CPI) numbers for March. According to FactSet, the expectations for year-over-year increases in earnings for the S&P 500 has been lowered but remains positive compared to a year ago. With energy prices recently pulling back, the March CPI report has the possibility of reflecting “peak” inflation but even if that is the case the highest levels of inflation in 40 years have already caused damage to the economy, by way of largely affecting consumer spending, and reduced purchasing power. And even if this is the highest point inflation reading, price increases are likely to remain persistent with elevated inflation for at least the next several months.
Despite what happens with the markets and economy, we can expect volatility to continue. This is a critical juncture to make decisions which will affect the outcome of your long-term financial plan. We are here to help you make the best choices to be successful. Do not try to be your own guide in this adventure, leverage the expertise and knowledge of professionals so you can choose wisely.
Have a great 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.
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