Giving Thanks, Market Timing & the Words of Chairman Powell
As we gathered around the Thanksgiving dinner table to count our blessings, few amongst us would dare give thanks for global stocks soaring well over 20% year to date. It would be quite inappropriate to do so. First, in comparison to your family’s health and happiness, the good fortune of the market is trivial. Second, how many around the table would even know what you’re talking about? If your house is anything like mine, then very few would comprehend terms like the S&P 500 or ACWI, much less appreciate the comment. I guess that I could reference the Dow and my addressable audience would grow marginally, but it still would be small. Nonetheless, for those of us who toil in the markets on a daily basis, 2019’s returns in stocks and bonds seem like a blessing – so much so that we may want to exchange all of our investments for cash, head to the sidelines and wait for a more opportune time to reinvest.
Yet the history books tell us that 2019’s return, assuming it holds, isn’t that abnormal. Since 1950, the S&P 500 has posted a total annual return greater than 25% on 16 occasions, or roughly 23% of the time (as seen in the shaded cells in Chart 1). Still, even if such returns aren’t that rare, then certainly a correction is quick to follow, right? Once again, history tells a different story. In 13 of the 16 occurrences, the S&P 500 posted a positive return the very next year. On average, the market rose by 13.7% in the 16 years where it returned 25%+ the prior year. It’s also worth noting that since 1950, the market has never dropped by 10% or more in the year following a 25%+ gain.
CHART 1: S&P 500 ANNUAL TOTAL RETURN (1950 – PRESENT)
This isn’t to say that the market is bound for good fortune again next year and that we should throw caution to the wind. Rather, it’s a reminder of the futility of trying to time the market. I talk to so many people who say, “I’ll get reinvested when the market drops,” or “the market is overvalued now, but I’ll get back in when it’s cheap.” Attempting to pick your spots to hop in and out of the market is an extremely difficult task. If you don’t believe me, I suggest you try this market timing simulator a few times and let me know how it goes:
In addition to the historical evidence which argues for being invested in the market, I’d argue that the backdrop is actually fairly constructive for investors. One may wonder why now would be a good time to be invested. Allow me to summarize a few of the grievances against this market that I often hear:
- At 10 years old, this bull market is already long in the tooth;
- Global growth is almost non-existent;
- We’re in the middle of a trade war;
- Bond yields are close to zero across the world;
- President Trump is a buffoon who has an affinity for debt and bankrupting businesses;
- The Democratic nominee will be a socialist who will attack businesses;
- Our country has $22T of debt and can’t grow more than 2% per year;
- Stock and bond valuations are too high;
- And last – but not least – millennials are lazy and don’t know how to work.
There’s a lot of material here to cover in one commentary, so I’ll try to make it short and sweet. While I may agree with a few of the statements above (no comment), there is one very important piece of information that has been excluded from this laundry list – in fact, I’d argue it’s the most important. If I could only have one piece of information when determining an investment strategy over the next year, it would be this: “Is the Fed becoming more restrictive or accommodating with its monetary policy?” On this front, let’s examine the recent statements of Fed Chairman Powell:
- “We would need to see a really significant move-up in inflation that’s persistent before we would consider raising rates.” 30, 2019 Federal Reserve Meeting Press Conference
- “Looking ahead, my colleagues and I see a sustained expansion of economic activity, a strong labor market, and inflation near our symmetric 2 percent objective as most likely.” 13, 2019 Testimony to the Joint Economic Committee of Congress
- “At this point in the long expansion, I see the glass as much more than half full. With the right policies, we can fill it further, building on the gains so far and spreading the benefits more broadly to all Americans.” 25, 2019 Speech to the Greater Providence Chamber of Commerce
That sounds quite accommodating to me, primarily due to the emphasis on the U.S. economy reaching a 2% inflation target. As seen in Chart 2 below, our economy has not spent much time running above a 2% inflation target (using the Fed’s preferred inflation metric – the PCE Deflator) over the past decade and sits firmly below that target now.
CHART 2: YOY %CHANGE IN THE US PERSONAL CONSUMPTION EXPENDITURE INDEX
Given that our economy doesn’t seem to be overheating from an inflationary perspective, and Mr. Powell believes that with the “right policies” we can spread the benefits to more Americans, I’m guessing that monetary policy will be quite loose for some time to come. Why does this matter? The supply of money and the cost of debt ultimately go a long way towards determining asset prices. The availability and cost of mortgages, auto loans, and business loans all help determine business activity in the economy.
You may recall that we’ve only had a couple of pullbacks in stocks over the past five years. Notably, neither were related to a President’s policies, a trade war, or our national debt. The first pullback was in 2015 – that just happened to coincide with the ending of the Fed’s Quantitative Easing (QE) Program and the beginning of its first rate hikes since the Credit Crisis. The other dip happened in the back half of last year…at the end of the Fed’s rate hike cycle. In both cases, the supply of money tightened, and the cost of credit increased. In response, asset prices quickly pulled back until such time that the Fed shifted back to a neutral or accommodative approach. In response, asset prices quickly rebounded and continued their upward ascent. This episode wasn’t unique. Examine stock returns over decades and you’ll see that there’s a strong correlation between asset returns and Fed policy. On the other hand, examine stock returns with GDP, the unemployment rate and political parties and you won’t find much of a relationship with any of them. While naysayers may hate the market’s “addiction to free money,” I’d argue that it’s nothing new…and likely isn’t “free”. Rather than free, I’d characterize our aggressive fiscal deficits and easy Fed policy as “borrowing” returns from future generations and pulling them forward to the present. Regardless, we have no time in this commentary to debate the morality of such actions or the ultimate consequences. We simply would like to highlight that our current policies, particularly as they relate to the Federal Reserve, are quite helpful to asset returns.
So, as you gather around the dinner table once again in a few weeks, I would advise against mentioning the S&P 500 in your prayers. However, should the topic arise (once you’ve exhausted the requisite time on sports, politics and religion), you may want to mention how much you appreciate the transparency of Fed Chairman Powell to tell us all that he plans to keep the money flowing in the U.S. economy. And should one of your relatives ignore your offering of gratitude and start to verbalize their “wait & see” approach to investing based on a political ideology or a hunch on market valuations, you may also want to recall the wise words of Warren Buffett:
“You’d be making a terrible mistake if you stay out of a game you think is going to be very good for the rest of your life because you think you can pick a better time to enter.” Source: CNBC, 2/17/07
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