Investing Is About the Future

Investing is About the Future Markets always love to surprise investors, which is just one more reason investors must truly understand why they hold each of their positions and what they should be doing for them in different market environments.

Investing is About the Future
Markets always love to surprise investors, which is just one more reason investors must truly understand why they hold each of their positions and what they should be doing for them in different market environments.

Five Things You Should Know

Equity Markets – were higher this week with U.S. stocks (S&P 500) up 4.27% while international stocks (EAFE) rose 3.65%.
Fixed Income Markets – were higher with investment grade bonds (AGG) up 0.68% while high yield bonds (JNK) rose 1.66%.
Fed 75 – Federal Reserve officials raised rates by 0.75% once again marking the biggest back-to-back increases since the 1980s. Chairman Powell left the door open to another 75 basis point hike at the next meeting but alluded to slowing the pace of increases in the near future. Officials now see the rate nearing the neutral estimates, and when pressed, Powell rejected the notion that the U.S. was in a recession citing a “very strong labor market”, and “…demand is still strong and the economy is still on track to continue to grow this year.”
Manchin Plays Ball – Senator Joe Manchin has agreed to a tax, energy and climate bill after being stalled by his initial opposition. Majority Leader Schumer announced Wednesday the economic plan would generate $739B in revenue with 15% of that coming from a corporate minimum tax, and $14B raised by taxing carried interest. The bill includes spending roughly $370B to fight climate change. While Manchin’s support will push a vote to floor next week, he rejected SALT, or the expansion of the state and local tax, which excludes a surtax on millionaires many House Democrats pushed for.
Key Insight – [VIDEO] Markets always love to surprise investors, which is just one more reason investors must truly understand why they hold each of their positions and what they should be doing for them in different market environments. [ARTICLE] This week provided another lesson in not timing markets. Tuesday’s sell-off had fear levels spiking and both another massive Fed hike and announcement of a recession laid it waiting, the market’s response? A 5% rally. We discuss how such market behavior is often the rule, not the exception, and share an article about what constructive “market timing” looks like.

Insights for Investors

“Never, ever invest in the present.” – Stan Druckenmiller

Be honest, in the midst of Tuesday’s ugly day if I told you that yes, the Fed would make history by raising rates by another 75 basis points and 2) the US would “officially” enter a recession -and you had to buy or sell stocks at Tuesday’s close what would you have done?

I don’t think it’s a stretch to say that most investors would have decided to get out of the stock market, and yet from Tuesdays lows into the week’s close, the market rallied almost 5%.

The good news is of course you don’t have to do anything as an investor and deciding to stick with your plan is just as much of a decision/action as choosing to buy or sell.

The other KEY TAKEAWAY that we do our best to remind you of with regularity is that the market most often moves in counterintuitive ways. One explanation is that investors naturally focus on the present (see quote above), while the market is always reacting to what lies ahead.

We’ve written about this at length before (see here) in a piece titled, What if You Knew? The gist of which is that our human logic rarely works in attempting to predict markets movements and this week is as great as an example of that as any.

The folks at Bespoke touched on this topic with their look at the market’s moves on Fed days pointing out that, “One of the primary reasons stocks have put up miserable performance numbers this year stems from the tighter monetary policy of the Federal Reserve. For that reason, we found it ironic that on all three days the FOMC has hiked rates this year, stocks rallied. On 3/16, the Fed kicked off the current rate hike cycle with a 25 bps increase in the Fed Funds rate, and in response, the S&P 500 rallied 2.2%. Seven weeks later, the size of the rate hike doubled, but stocks still rallied with the S&P 500 surging just under 3% in what turned out to be the second-best day of the year. Six weeks later on 6/15, in response to the mirage of surging inflation expectations in the Michigan sentiment report, the Fed dropped a 75 bps hike on the market and yet stocks still managed to rally with the S&P 500 rising 1.5%.

In other words, the S&P 500 is down 17.7% this year, but if you had only invested in the market on days when the FOMC hiked rates, you would be looking at a YTD gain of 6.8% in just three days. Conversely, if you had avoided the market on those three days and been long the rest of the year, you’d be down 23% YTD. Nobody ever said the market had to make sense.”

The other big news this week of course was the announcement that US GDP had declined for a second consecutive quarter (Q2 showed a drop of 0.9%), the classic definition of a recession. However, as we have been warning investors for some time a) don’t get too hung up on technical definitions and b) there was a high likelihood that markets had already priced in this reality.

First Trust Chief Economist Brian Wesbury had this to say regarding the big announcement, “…payrolls growing 457,000 per month, lower unemployment, and industrial production up at 5.0%+ annual rate. These things don’t happen during recessions, and we would not be surprised if at least one of the first two quarters of the year is later revised positive.”

His points and potential prediction are some of the possible reasons the market shrugged off the report and surged higher. Though we would continue to stress that the most likely explanation for the market’s recent resilience and a solid historical reality to encourage investors that a floor could be in is that traditional recessions usually see market drawdowns of 21.6% on average, and we’ve already seen a 23%+ decline. (See chart below)

In Closing

The choice is yours on how to view the unpredictability of markets. Is it something that scares you or frees you due to its unpredictability and counter-intuitive nature?

I, of course, would strongly argue for the latter and to use that newfound time and emotion to both gird your plan and spend on the important reasons you became an investor in the first place (family, friends, passions, etc.).

The day-to-day movements of markets will always frustrate those with a trader’s mentality, but such things pose no threat to investors who embrace the other truth which is that such movements and frustrations only derail the plans and goals of those who react.

Have a wonderful summer weekend,

Tim and the team at TEN Capital

______________________________________________________________

How Two Reactions to Volatility Could Have Resulted in a $894,314 Difference

by The Hartford Funds

When the market plunges, seemingly safe decisions can lead to missed opportunities.
In 1991, researchers at the University of Illinois tested 20 pilots in a flight simulator. These pilots all flew according to visual flight rules, meaning they flew only when conditions were clear enough to see the ground and other aircraft. They didn’t know how to use flight instruments. When the researchers created poor visual conditions, all 20 pilots crashed—in an average of 178 seconds. Next, the pilots were given two hours of flight-instrument training. After the training, all the pilots were able to fly successfully.

Likewise, as an investor you want to navigate periods of volatility successfully. But without historical perspective, when the stock market takes a dive, you may be tempted to make decisions that could hurt your long-term investment results. But volatility is not only expected, it can also be an investment-growth opportunity.

Perseverance Matters
When the stock market doesn’t provide positive returns in a particular year, investors often feel uneasy, overlooking the fact that the positive returns only come as an average return over time—not every year.

Naturally, investors desire more consistency than the chart in Figure 1 demonstrates. Given that the S&P 500 Index¹ had an average annual return of 12.35% from 1982 through year-end 2021, many investors may expect a similar return in an individual year. Yet, the Index returned between 9% and 12% annually only three times during that time period. Usually, it was above or below the average annual return of 12.35%, sometimes significantly.

Figure 1: In the Short Term, the Stock Market Appears Really Volatile
S&P 500 Index Quarterly Returns % (1982–2021)

Perspective Can Change Investors’ Perception
Some investors view volatility as entirely bad, making it difficult to accept that volatility can represent the potential for gain as much as the potential for loss. More importantly, some investors forget that volatility, whether it lasts a day, a week, or a year, has historically been short-term.

Figure 2 shows the results of that volatility with a $10,000 investment in the same index as Figure 1, over the same time period. Instead of focusing on the stock market’s ups and downs, investors can see the overall effect of the 12.35% average annual return.

Figure 2: The Same Investment Viewed from a Long-Term Perspective
Long-Term Growth: Growth of $10,000 Invested in S&P 500 Index (1982-2021)

Two Very Different Reactions to Volatility That Led to an $894,314 Difference in Returns
In Figure 3, two investors began with $10,000 in the S&P 500 Index on 12/31/81. From there, each took a very different investment approach. Every time the stock market dropped 8% or more in a month the apprehensive investor (shown in orange in Figure 3) panicked and transferred $2,000 to T-Bills, which are often viewed as safe, conservative investments. The opportunistic investor (shown in blue in Figure 3), on the other hand, did the opposite by investing an additional $2,000 in the Index.

Figure 3: Volatility Can Provide Significant Opportunity
Two Hypothetical Approaches to Volatility: Growth of $10,000 Invested in S&P 500 Index (1982–2021)

The Big Surprise
The apprehensive investor was able to avoid some of volatility’s short-term effects. But after several moves, the apprehensive investor’s assets were completely invested in cash, causing them to miss the significant growth experienced by the opportunistic investor.

The opportunistic investor chose to not only tolerate but take advantage of volatility. Ultimately, the opportunistic investor enjoyed a considerably higher investment value—more than double the apprehensive investor’s.

Despite the Growth Potential of Equities, Market Drops Can Still Be Uncomfortable
Keep in mind that there have been seven bear markets from 1982–2021.² The seventh and most recent bear market began in March 2020. The previous six averaged a little under one year in length and the average decline was 35%.² Historically, the probability of a bear market occurring is only about one in every four years. But what’s more important than what happens during these bear markets is what happens after they occur. For example, on 12/31/1982, the S&P 500 Index was at 141. On 12/31/2021, the S&P 500 closed at 4,7662—more than 33 times higher than it was at the end of 1982.

When the Market Gets Rough, Remember These Three Things
First, it’s natural to want consistent returns. But in the short term, the stock market can often be quite volatile. Second, looking at short-term volatility from a long-term perspective can change its significance completely. Third, viewing volatility as an opportunity instead of purely a threat can lead to far different results.

Don’t Fly Without Instruments
When market corrections or bear markets occur, getting out of the market is tempting. Like the pilots flying in the simulator, not seeing things clearly can lead to poor outcomes. Even though market drops are uncomfortable, there’s value in sticking with a sound investment plan for the long term.

Data, Just the Data

Data points this week included:

U.S. Jobless Claims – fell by 5K to a claimant count of 256K for the week ending July 23^rd. This was slightly above market forecasts of 253K. The four-week moving average has increased by 6.25K to 249.2K.
U.S. New Home Sales – contracted (8.1%) from the month previous to an adjusted rate of 590K for June. This was far below expectations of 660K, and the lowest reading since April 2020. Sales in the West decreased by (36.7%), but rose in the Midwest by 42.3%. The median sales price of a new home was $402.4K, and inventory supply has moved to 9.3 months.
U.S. GDP – faltered for the second quarter in a row, with the economy shrinking (0.9%) in Q2, following a (1.6%) decline in Q1. Inventories and business investment brought down the reading as residential investment fell (14%), goods spending was down (4.4%), and government consumption contracted (1.9%). PCE slightly rose 1% and net trade made a positive impact for the first time since 2020.
U.S. Adv. in International Trades in Goods – the trade deficit has appeared to have narrowed to ($98.2B) in June, after a reading of ($104B) in May. This marks the lowest deficit this year with exports climbing to a high of $181.5B. Imports fell (0.5%) to ($279.7B), with vehicles and food declining (7.8%) and (1.1%), respectively.
U.S. Consumer Confidence – the Univ. of Michigan consumer sentiment report rose from a record low of 50 in June, to 51.5 in July. This was in line with estimates, with economic condition subindex up to 58.1 and the expectations gauge unchanged at 47.3 – the lowest since 2009. The increased reading slightly eased buying conditions for durables.
U.S. Durable Goods Orders – rose 1.9% MoM in June, which is the most since January, and marks the fourth consecutive month of an increase. Business spending plans remain strong despite high interest rates and inflation. Excluding transportation, new orders went up 0.3%. Orders for non-defense capital goods excluding aircraft rose 0.5%.
U.S. Personal Income – bumped up 0.6% MoM in June – unchanged from the month previous. This marks the fifth consecutive month with an increase, as increases in compensation and proprietors were the main contributions.