Fueled by endless low interest rates and unending government spending, U.S. inflation accelerated to over 6% annualized as Dow Jones Averages of leading U.S. stocks moved to a record 36,000. In 1999 during a previous booming stock market, two economists, James Glassman and Kevin Hassett, published Dow 36,000. The Dow had just broken 10,000 in those heady days of a “new era.” Glassman and Hassett predicted the Dow would hit 36,000 “very quickly.” It took 22 years for that to happen.
Signs of inflation today are everywhere: Social Security checks are going up 5.9% for 2022. Gasoline at the pump is over $4 and, in some places, $5 per gallon. Food prices give sticker shock. New autos sell at premiums (if you can get one), and used autos are hugely marked up.
Very likely some speculation in stock market prices that you read about is related to monetary inflation, as well as supply and demand imbalances due to previous government mandates and lockdowns, as well as policies that pay people not to work or to keep them from working.
Sometimes, it seems like stocks shouldn’t be doing well when the economy doesn’t feel like it can support a rapidly rising market. But collectively, participants are looking forward beyond present conditions and creating a market equilibrium of buyers and sellers.
Professionals use all information available to them to determine their expectations about the future — including their expectations about inflation. Whether prices are hitting new highs or lows, market prices fairly aggregate all information available to or discoverable by buyers and sellers.
At any given moment, some media commentator has a story about why you should either A) buy more or B) sell more securities. But excessive focus on anxiety-producing headlines or guru predictions leads to misbehaviors causing headaches and/or reduced returns for those who already have an informed investing strategy.
Stay Patient and Stay Disciplined
The sudden market downturn and rebound last year provided our clients a valuable gift — the gift of experiencing a successfully implemented strategy when they stayed patient and stayed disciplined.
Modern capital markets have evolved to effectively handle economic, political, and social uncertainty, processing information almost instantaneously in real-time as unexpected events transpire. It is impossible to know how the post-pandemic recovery will play out in the U.S. and around the world, but our economic expectation is that bearing compensated risks in an informed manner will fairly reward investors with positive expected returns. And those positive returns account for inflation, whether transitory or not.
That was the case in March of 2020 even as the pandemic began: the S&P 500 Index quickly recovered from the bad news, returning roughly 70% over the next nine months. During past Ebola and swine-flu outbreaks, as well during the global financial crisis from its low point in March of 2009, the subsequent recoveries rewarded those willing to weather the initial painful decline.
Exhibit 1: U.S. Market Intra-year Gains and Declines vs. Calendar Year Returns1979–2020
In US dollars. Data is calculated off rounded daily returns. US Market is the Russell 3000 Index. Largest Intra-Year Gain refers to the largest market increase from trough to peak during the year. Largest Intra-Year Decline refers to the largest market decrease from peak to trough during the year. Frank Russell Company is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes.
Past performance is not a guarantee of future results. Values change frequently and past performance may not be repeated. There is always the risk that an investor may lose money. Indices are not available for direct investment Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Values change frequently and past performance may not be repealed. There is always the risk that an investor may lose money. Even a long-lerm investment approach cannot guarantee a profit.
Successful wealth accumulation has no shortcuts. Academic research suggests that success is largely predicated on planning with a robust investment approach, a long-term perspective, and self-control to stick with the plan when a crisis inevitably happens. There will always be another “crisis of the day.” Enduring the consequential discomfort of market volatility is the price any true investor must pay.
Sharp stock market declines may last a few days or a few months at time. That does not mean you should anticipate a down year. Exhibit 1 shines a light on that common fallacy and reminds us how quickly markets can swing. During the month of March in 2020 just mentioned, we experienced 5 of the best 25 days and the largest 3-day surge in Dow Jones history, and yet the year-end returns were up.
Exhibit 2: Selling and Missing Strong Returns Can Impact Total Returns
Performance of the S&P 500 Index, 1990-2020
Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. In US dollars. For illustrative purposes. The missed best day(s) examples assume that the hypothetical portfolio fully divested its holdings at the end of the day before the missed best day(s), held cash for the missed best day(s), and reinvested the entire portfolio in the S&P 500 at the end of the missed best day(s). Annualized returns for the missed best day(s) were calculated by substituting actual returns for the missed best day(s) with zero. S&P data© 2021 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. “One-Month UST- Bills” is the IA SBBI US 30 Day TBill TR USD, provided by Ibbotson Associates via Morningstar Direct. Data is calculated off rounded daily index values.
Being out of the market even briefly decreases expected returns as we see in Exhibit 2. Not only can timing mistakes be damaging, but also being wrong may cause great regret. When trying to “time” the market to avoid more “losses,” not only must you worry exactly when to exit — but you must be right about exactly when to get back in. Being correct once is difficult; being correct twice is rare.
Versions of timing applies not only to the market broadly, but also applies to market segments. Those focused on buying popular growth stocks due to recent high performance and having sold out their value and smaller stock dimensions which did relatively poorly last year, now may be questioning their timing. Over the rolling twelve months ending September 30, the U.S. large value stock index returned 35.0% while U.S. large growth returned 27.3%. A U.S. small value stock index returned 63.9% while small growth returned 33.3%. For international developed equities, a value index was 32.6% for the rolling twelve months while the large growth index returned 20.5%. Lastly in emerging markets, value was 28.4% and growth 9.3%.1
Many investors frequently abandon established wealth planning principles when a fast advancing bull market defies economic logic. All too often after economic rationality eventually prevails, the wealth of investors who made big market bets is transferred to those with a disciplined wealth strategy focused on matters more important than just money, like the financial security of their family.>
Decide to control what you can control: have a diversified investment plan structured along the dimensions of expected returns aligned with your needs, goals, and risk tolerance, planned well in advance of a crisis. Planning with a CFP® professional will enable you to look beyond the daily volatility to the long-term potential of capital markets, and enable you to stay disciplined in these troubled times.
1Paul Byron Hill, Global Market Review: 3rd Quarter 2021, Professional Financial Strategies, Inc. See report for index sources.