A Few Words on the Current Economic and Market Environment
“The most important quality for an investor is temperament, not intellect.” -Warren Buffett
The financial media is shrieking the dreaded “R” word (Recession) for what seems to be enough times a day for the facts to cease to matter. This seems to be the malignancy the media is focusing on after having previously predicted total doom due to the war in Ukraine and high inflation.
Market corrections are a common occurrence. As we have shared before, the average annual drawdown from a peak to trough in the S&P 500 has for many decades been about 15%. The current decline is very close to that number. Whether it will continue to decline beyond 20% into a Bear Market is anyone’s guess.
Bear markets and recessions are also common occurrences, but they happen less frequently and on average about every 5-7 years.
A recession is either coming or it’s not. When you get out of the market in contemplation of a recession, you have set the probability of it happening at 100%. Can you really be that sure of anything?
If a recession comes, there is no reliable way to predict when it will begin, how deep it will go in terms of peak-to-trough GDP decline, or when it will end.
There is absolutely no reliable correlation between the onset of recession and an equity market top—nor between the end of a recession and a market trough.
If anything—being the forward-looking discounting mechanism that it is—the equity market tends to trough well before the recession ends—and very long before the NBER confirms that the recession is over.
We therefore find that the economy cannot be consistently forecast, or the market consistently timed.
The high inflation environment we are in is due in large part to the Federal Reserve expanding the money supply far too much and for too long, but justifiably in response to the COVID induced steep economic decline. It is now faced with the necessity of withdrawing that excess by shrinking its balance sheet and raising interest rates in order to get the inflation it has created back under control. You want them to do this.
The attached
infographic illustrates the myth that Fed tightening equals equity market losses by highlighting the annualized gains of the last six interest rate cycles.
It may take a recession to break the back of this inflation (or it may not). If it takes a recession to wipe out the excess inflation and it causes the equity markets to decline further, a sane long-term investor must not merely endure this but embrace it. Fed Chief Paul Volcker did exactly this 40 years ago by raising interest rates and causing a recession. It wasn’t pretty at the time with interest rates shooting to 20% and the S&P 500 declining 27%. But with inflation dead, the greatest bull market of all time—from August 1982 until March 2000—ensued. The cure is not worse than the disease.
We also remind you that we built your plan together and included significant margins of safety in our assumptions as well as the stress test applied to the projections. For those drawing on your investments in retirement, remember that we are generally holding 4-6 years of reserves in bonds that historically carry much lower risk than stocks. We are not suggesting that we’re going to need to draw on those reserves. We are inviting you to be comforted once again by the fact that we have them.
Your portfolio was and remains a servant of your financial plan, which in turn was derived from your most cherished financial goals. That progression again is goals—plan—portfolio. You don’t see “current events” anywhere in that progression for a very good reason.
As we have stated many times, all successful long-term investors are continuously acting on a plan. All the failed investors we’ve ever encountered up close were continually reacting to current events—and always the wrong way.
Lastly, we are all emotional human beings. It is normal to experience fear and anguish in the face of uncertainty. Reacting to that fear by disrupting your well laid plan and portfolio will almost certainly prove to be a mistake in the long-run.
Please feel free to reach out if you would like to discuss this further. We’re always happy to hear from you.
