A Bear Hug (and Kiss)
The definition of a bear market is one in which the value of the stock market, or more precisely a particular stock index, falls by 20% or more from its peak. For those who have cash available to invest, a bear market can provide excellent opportunities. Famed money manager Shelby Cullom Davis was quoted saying, “You make most of your money in a bear market, you just don’t realize it at the time.” He was referring to the fact that stocks can be bought cheaply during bear markets. Sometimes these are referred to as generational buying opportunities but given that we have experienced three (and teetering on a fourth) bear markets since the turn of the century these seem more like once in a decade, or once every few years, opportunities. On the other hand, if you are fully invested the goal is not to panic and sell at a low, missing out on a potential rebound. Watching your account value drop precipitously undoubtedly causes concern, especially if it represents the savings you worked hard to build and will be relying upon to maintain your lifestyle in retirement. We always like to remind our friends and clients that investing in the stock market should be a long-term proposition and not based upon short-term movements in the markets.
Despite a 3% rise on Friday, the Nasdaq Composite remains more than 25% off its highs and seems to have fully embraced being in a bear market as investors have dumped tech stocks. The S&P 500 “kissed” a bear market last week, missing it by only a few points before staging a rebound. The major indices again finished the week lower, marking six weeks in a row with losses for the first time since 2011. A strong bounce-back rally on Friday was led by the most speculative names, which are also those that have lost the most during the recent market carnage. While this bounce does give hope we are at or near the bottom, we remain skeptical since the higher quality names were not the market leaders. Also, when a bottom is truly reached we would expect to see capitulation, which is when a significant portion of investors succumb to fear and sell over a short period of time, causing stock prices to move even lower. Despite numerous headwinds in the short-term, we remain optimistic in the long-term. It seems much of the “bad” news, including multiple interest rate hikes from the Fed and slowing growth, have already been factored into the market. Quarterly earnings reports have been solid with a solid majority of companies beating estimates. Bearish signals remain in the markets, such as low levels of investor sentiment, but these often are contra-indicators since individual investors tend to lose confidence right when the market reaches the bottom.
Last week’s Consumer Price Index (CPI) report showed that consumer prices increased by 8.3% over the past year, which was a little higher than expected, but lower than the previous month. This report was interpreted by many to mean that inflation is stabilizing even though it remains elevated, however it will most likely take months to determine if this is the beginning of a trend lower or just some minor month-to-month variances. Housing costs make up over 40% of the CPI measure so it can be seen how the strong real estate market and associated increase in real estate prices has had an outsized impact on the CPI being reported. Higher mortgage rates coupled with increases in real estate prices has led to housing now becoming less affordable. There seems to be a high probability of the real estate market slowing and while prices may not drop, they very well could level off which would then slow the increases in CPI being reported. For many people, especially those with a fixed rate mortgage, most of the cost of housing is fixed and will not change. Inflation reported by the government is a good indicator of the direction of inflation but is probably not the most accurate measure of the true magnitude of inflation for each individual and therefore it is important to determine your own rate of inflation by comparing differences in prices of the goods and services you spend your money on.
The other “bare necessities,” which include transportation, food, and medical care, combined make up just under 40% of CPI and this is where we continue to see significant price increases. For many people, when the prices of essential items increase there is less money to spend on discretionary items. For example, if forced to choose between buying a loaf of bread and a Netflix subscription, it is safe to assume any rational person would choose the loaf of bread. Sharp increases in food and energy prices leading to consumers cutting back on discretionary spending is a major reason why consumer sentiment is now at its lowest level since 2011, as was reported last week by the widely followed University of Michigan Consumer Sentiment survey.
It is expected that recent geo-political events will have a lasting impact on the world order, especially global trade, so we expect higher food and energy prices to continue. At some point they should stabilize, but even when they do, prices are already much higher than they were previously, creating burdens for many households. Again using bread as an example, if the cost of a loaf of bread increases from $2 to $3, that would be a 50% rise in inflation. If the price remains at $3 then inflation is reported as being zero, however the cost of that loaf of bread remains 50% higher than before. Eventually we expect the pace of inflation to subside, but prices will remain significantly higher. To illustrate how this could affect your retirement spending – using the Rule of 72 for some quick math, if inflation is steady at 3%, purchasing power is cut in half in approximately 24 years. If inflation is steady at 6%, purchasing power is cut by three-fourths during the same time period; meaning the spending power of one dollar today will only be 25 cents at the end of 24 years, which is the amount of time many people now spend in retirement. It is very unlikely the rate of inflation will remain steady for that duration, but this helps demonstrate the importance of planning for necessary increases in the amount of money needed to maintain your lifestyle.
The focus of the upcoming week will be on retail sales with monthly retail sales reported from the U.S. Census Bureau on Tuesday and earnings reports from giants Wal-Mart, Target, Lowe’s, Home Depot and Macy’s throughout the week. We will especially be watching for forward guidance from these companies since wholesale costs continue to rise, putting pressure on profit margins and sales since price increases are frequently passed along to consumers.
We are frequently being asked when we will reach the market bottom. Of course we do not have a magic crystal ball but perhaps we have in the short-term. We do remain cautious since we do not think we have yet experienced the worst since headwinds from rising interest rates, slowing growth and inflation persist. Hopefully we are wrong and the market rebounds from here, which could occur since so much has seemingly already been priced into the market. Regardless, there are going to be challenges ahead. Corrections and bear markets are part of a normal market cycle, and we remain confident brighter days will eventually come. Give us a call if you would like to review your portfolio to ensure it is positioned properly for all market conditions.
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.
Office phone # 952-460-3260