Hitting the Bullseye
As the S&P 500 sits on the edge of bear market territory, being down almost 20% from its peak, investors are wondering if we are near the bottom and it is time to buy or are we going to experience more pain and should they sell. Some people expect to time the market perfectly, buying at the bottom and selling at the top, and understandably so since this is how you could maximize returns in the market. However, the reality is that while you might get lucky and sell near the top or buy near the bottom once or twice, it is nearly impossible to time the market perfectly, especially on a consistent basis. Instead of trying to time the market and hit the bullseye, a better strategy is to accept the fact that the stock market not only moves up but also does move down from time to time and this is just part of the normal cycle. It is so much more important to have a solid financial plan in place to ensure you remain on target.
This past week brought some real surprises in the form of earnings reports from major retailers, which did not hit the bullseye nor were anywhere close for that matter. Earnings reports from the Bullseye itself, Target, as well as Wal-Mart showed that consumer spending has shifted from high-margin discretionary items to lower-margin essential items, namely food. Revenues were higher than a year ago but earnings were much lower since the cost of goods sold was higher and those costs are not able to be fully passed on to consumers. These reports and what they represented in terms of consumer behavior sent markets lower with a major sell-off last Wednesday, sending the S&P 500 to its seventh consecutive losing week for the first time since 2001. It would have been worse had there not been a strong recovery at the end of the day Friday, a day in which we saw the S&P 500 break the bear market threshold of being 20% below the high reached on January 3rd of this year. Investor sentiment is moving lower with many bearish indicators flashing caution signals, not to mention momentum seems to be moving in a negative direction. Often in the past, it is when sentiment was at its worst that the markets reversed and moved higher.
The best way to get better at something is to gain more experience, or simply practice. The same can be said of the stock market – sensible investors tend to improve with experience and by studying history. Most investors can remember the bear markets of 2001-2003 and 2008-2009 but they might be surprised to know that since 1980 the S&P 500 has averaged a downturn of 14% per year. There have been seven bear markets since 1980, with each one averaging about six and a half months in duration. This includes two separate bear markets during both the tech crash of 2001-2003 and again during the financial crisis of 2008-2009. Between these separate bear markets, the S&P 500 rebounded 21% and 24%, respectively. With momentum on the downside, it seems the markets are bound to move lower but if you were to sell at this point, it would be at the risk of missing any potential rebound. Warren Buffet perhaps said it best when asked why he does not try to time the market, to which he replied, “You have to be right twice.”
To find clues about the future direction of the market, sometimes the best place to look is the market itself. The stock market tends to be somewhat irrational, often for long lengths of time, but eventually seems to come to its senses. The recent cooling-off of speculative technology stocks and the tech crash of 2000-2001 are examples of this. But it is the bond market that more often provides guidance, such as a yield curve inversion foretelling a recession. This is why we now have some optimism – bond yields, especially longer duration, have steadied and even fallen a bit recently. This is an indication the bond market may have been ahead of itself or is now expecting a less substantial rise in interest rates. If the latter were the case, it would be because inflation slows more than is currently expected, which could provide a boost to the stock market.
The pullback in rates and possibility of lower inflation could be due to the prospect of demand destruction, which occurs when persistent high prices or limited supply result in reduced demand for goods. The earnings reports of the major retailers last week indicated this with large buildups of inventories. A reduction in demand is likely to lead to lower prices from retailers who need to sell off inventory, which should help put a damper on inflation. And thus, while we anticipate the Fed to continue to raise interest rates in efforts to combat inflation, ironically it may not be the Fed that tames inflation, but rather inflation itself. Higher energy prices will continue and supply chain issues persist, but we are now more optimistic that inflation will moderate over coming months, however it will likely remain elevated above long-term averages for the next year or more.
The upcoming week includes more earnings from retailers, including Costco and Macy’s. There will be an abnormally large focus on Costco given what occurred last week. The major economic release will be Personal Consumption Expenditures (PCE) which is the Federal Reserve’s preferred measure of inflation. It is expected this number will remains elevated, indicating a continuation of above average inflation, but the comparison to a month ago should not matter much since we are more interested in the trend versus single data points. Given the composition of how this data is compiled, it should provide a view into the current state of consumers and what they are spending money on. Taking a deep dive into the data, it is likely to show that inflation remains elevated but may be decelerating with consumers spending more on essential items than on discretionary items, similar to what we heard from retailers last week.
We continue to remain cautious on the markets but are gaining optimism. The farther the market drops, the closer we are to the bottom, and it seems the market is like a coiled spring ready to quickly “pop” when released which is why we could see a swift rebound. Headwinds remain, including the prospect of higher interest rates, continued inflation and slowing growth, but none seem insurmountable and it is likely we are entering a new phase in the economy where this becomes the new normal, at least for the next few years. Once the markets accept that, they are likely to move on and forge ahead. It will take some time but eventually energy prices will fall, further lessening inflationary pressures. This will happen as a result of greater supply or new technology, both of which will take some time to come online.
At this point you need to ask yourself where you see the stock market in 3 years, 5 years or 10 years. If you think it will be higher then you should remain invested. If you think it will be lower then you should seek alternatives, knowing that some may also be money-losing propositions in the sense you will experience an erosion in purchasing power with returns that are unable to keep up with inflation. Markets tend to move up and down, often times dramatically in the short term, but history has shown over the long-term stock prices tend to move higher. If you have savings you expect to spend in the short term, it should not be invested in the stock market. Only money you do not plan to spend for a few years should be invested so you have time to ride out volatility. When it comes to investing you do not have to pick every investment perfectly or time the market exactly to find success in reaching your goals; you do not have to hit the bullseye, you just need to have a solid financial plan and ensure you remain on the target.
Have a great week!
Nathan Zeller, CFA, CFP®
Chief Investment Strategist
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