“Before you attempt to beat the odds, be sure you could survive the odds beating you.”
– Larry Kersten
After a blockbuster year of gains for stock market investors, January did not follow through with gains at home or overseas. All of the equity market indexes we follow posted negative numbers for the month. Bonds were also negative on fear of aggressive short-term interest rates hikes from the Federal Reserve. The dollar continued to strengthen, as did commodities.
All data as of 2/01/2022, Source: Wells Fargo Investment Institute. [Wells Fargo Investment Institute, Inc. is a registered investment advisor and wholly-owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.]
According to Investopedia, since 1957 the S&P500 has posted an average annual return of around 10.5%. Last year was extraordinary with this benchmark index gaining more than 27% without a “correction” of more than 4.9%. In our Stock Market Outlook – 2022 – Participate & Protect we noted that a repeat performance in 2022 was unlikely. We argued the market volatility that was lacking in 2021 would be back. Well …. we didn’t have to wait very long for the stock market to wobble.
We did not find this to be much of a surprise. Markets entered the new year with an unusual calm that was not in line with what we were seeing below the surface of the big indexes. From a technical perspective two of our favorite indicators – MACD and RSI – were flashing signs of caution. Underneath the broad market indices, we also noticed that many more stocks were struggling than what the market indexes were showing. A small number of the largest stocks were leading the benchmarks higher as smaller, less relevant to index performance companies, were struggling.
Put another way, the stock market looked fine while the market of stocks was struggling.
Chart #1: Source: www.stockcharts.com
Meanwhile, bonds were not doing much better, with the Bloomberg Aggregate Bond Index posting a big (for bonds) negative return in January. With the turn of the calendar the market became much more negative in regard to interest rate hikes. The consensus view of 2 or maybe 3 quarter point hikes to short-term interest rates in December turned to thoughts of 5 rate increases as well as the possibility of more aggressive half point moves from the Fed. As a result, rates moved higher with the 10-year Treasury ending the month at 1.78%, up 0.27% (chart #2).
Chart #2: Source: www.stockcharts.com
Commodities, on the other hand, continued to trend higher, with the CRB Index posting an almost 10% increase, which was led by oil and natural gas. Just as not all stocks are the same, not all commodities participated in the party. Specifically, the metals gold, silver, and copper all were slightly lower for the month.
Chart #3: Source: www.stockcharts.com
Remember Your Timeframe
We have said it before and will say it again – know your timeframe as an investor. We can honestly say that we have never received a call from a client who was happy that their statement was lower than it was the previous month. We can also, in all honesty, say that these short-term moves in the market only really matter IF your timeframe is immediate or the next few months. And if that is the case, you had no business taking on stock market risks.
For clients who are in the distribution phase, Magellan Financial generally recommends having adequate liquidity to cover expected spending needs for a sustained period of time. This helps avoid the possibility of selling into poor markets to cover short-term spending needs. We do not want to see a forced lifestyle change caused by too much market risk for the investor during market volatility.
All that said, even for client who is in the distribution phase, the investment timeframe is measured in years or decades, not weeks and months. What happens tomorrow can make for great conversation, but it is just market noise.
Market corrections are common, even if we sometimes forget this uncomfortable fact. The 10.5% average stock market return we mentioned earlier comes to those with patience and understanding of how markets work. Being reactionary can be fatal to long-term returns.
See, an average return is just that, an average return. In any given year the stock market can be up much more than one would expect (see last year, 1998, and 1999 as examples) or much lower than one could ever imagine at the start of the year (remember 2008?). The excess return you get from investing in the stock market is BECAUSE of the volatility, not DESPITE the volatility.
Over the intermediate and long-term what is really important is the economy, corporate earning and interest rates. The economy drives earnings while interest rates drive market valuations. In the long-run earnings are what drive stock market returns upward.
Staying in the market while keeping your larger picture in focus is a key component to investment success.
Chart #4: Source: JPMorgan Guide to the Markets
Don’t Be “That Guy” & Make These Common Mistakes (AGAIN)
When we think about the mistakes investors make that can limit returns, we see four themes that consistently emerge. IF one of these four profiles sounds a little too familiar, there’s still time to correct your ways:
1. The investor who panicked and went to cash: This tends to be either the investor who is overly aggressive, or the investor who was right about going to cash at some point in the past. The problem with the cash out scenario, even when correct, is that you now have to decide when and how to get back into the market. Put another way, you have another chance to make another mistake. History tells us that the best of the best traders can’t perfectly time the market. So, what are the chances you are one of the best traders? Possible, but not probable. We know that the best days of market performance often come shortly after the worst days (source). Attempting to time the market is setting yourself up for failure. Time, not timing, is an investors best friend.
2. The investor who doesn’t have a diversified portfolio: This can happen either by design or through chasing performance. Being all-in to the hot area of the market works until it doesn’t. Given the propensity for markets to move up in a steady manner then move lower quickly, can lead to big swings in performance. Diversity among different investment styles helps smooth out investment returns. Often, last year’s best performing asset class in this year’s worst performing asset class.
Chart #5: Source: JPMorgan Guide to the Markets
3. The investor who has a concentrated position in one or a handful of individual stocks: This is #2 on steroids. Even the best performing companies don’t stay there forever and go through corrections – sometimes temporary, sometimes permanently. Name us your favorite technology stock and we can show you a pullback that you likely wouldn’t want to or likely have the temerity to sit through.
4. The investor who doesn’t have (and follow) an investment plan: Fail to plan, plan to fail. Unless you are a day trader who is in the stock market for the game of it all you are an investor. As an investor you should have a plan and a reason for what you are doing. That plan will keep you from making mistakes #1-3.
There are many new investors out there who are making these very mistakes right now. Some got started investing post-2009 and have enjoyed a wonderful bull market in growth stocks. Others started trading on their phones in the past few years. What these investors have in common is they have not invested through major changes in the markets. “Buy the dip” is a common phrase you hear from this crowd. That works until it doesn’t.
Inflation
There has been a lot of talk about inflation, how bad it could get, and what government can or should do to tame it. Earlier we discussed interest rate increases, which is a standard way in which the Federal Reserve can help get rising inflation under control. Expectations are that the first increase to the Fed Funds rate will come at the Board’s March meeting.
Reporting by Jeff Stein and Rachael Siegel at the Washington Post identify 12 ideas from leading economists that can help solve the problem. None of these, in our opinion, are short-term fixes to what currently ails us. Here are three we find compelling:
- Make America produce again: global supply chains have been a mess and the problem hasn’t gotten much better in the past 2 years. Policies that are designed to bring production back onshore are not only helpful in containing inflation but can help reverse the decline in American productivity.
- Invest in child care: parents have historically some of the highest labor force participation rates but need to have stable, affordable child care options to both get and keep a job. A system that was teetering pre-covid is now in worse shape. The cost of care is high, the pay to workers is low, and the industry is not compelling to invest in due to low profitability. Supply-side investments could help add workers to the system and enable parents to reenter the workforce.
- Use antitrust laws to curb corporate profiteering: the pandemic wasn’t caused by corporations, but many of the problems we currently face is a result of decades of Corporate America’s pursuit of short-term profits, in many cases fueled by M&A activity. Capitalism is much less efficient with a small handful of large companies than it is with a larger number of small players competing for business.
There is some good news on the inflation front, however. From a monetary perspective, inflation is at least in part a result of the money supply. The more money available to purchase goods, the more upward pressure there is on prices. The M2 Money Supply tends to lead the rate of inflation by 9 months. Chart #6 shows the spike in money supply that preceded the current spike in inflation. It also indicates a drastic reduction in M2 Money Supply that can help constrain inflation as the year progresses.
Chart #6: Source: Advisoranalyst.com
Final Thoughts
Markets are not rationale but rationale at the same time. Emotions – mainly greed and fear – are what drive markets in the short term. Corporate earnings, on the other hand, drive the values of both individual stocks and the stock market over longer periods of time. The key to success is to not let the irrational thoughts in the moment get in the way of the rational understanding that profits drive the stock market higher over time.
This is an important concept to remember both in the good times and not-so-good times. Market volatility can lead to poor decision making. Don’t be “that guy” (or girl) making bad decisions. Have a plan and stick to it. Set an asset allocation that works for you and your situation. Have a financial advisor who can help with your investment and wealth planning.
Financial success isn’t about trying to beat the odds, but about not letting the odds, and your emotions, beat you.
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Wells Fargo Advisors Financial Network did not assist in the preparation of this report, and its accuracy and completeness are not guaranteed. The opinions expressed in this report are those of the author(s) and are not necessarily those of Wells Fargo Advisors Financial Network or its affiliates. The material has been prepared or is distributed solely for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Additional information is available upon request.
Asset allocation and diversification are investment methods used to help manage risk. They do not guarantee investment returns or eliminate risk of loss including in a declining market.All investing involves risks including the possible loss of principal invested. Past performance is not a guarantee of future results.
Index returns are not fund returns. An index is unmanaged and not available for investment.
Dow Jones Industrial Average: The Dow Jones Industrial Average is a price-weighted index of 30 “blue-chip” industrial U.S. stocks.
S&P 500 Index: The S&P 500 Index consists of 500 stocks chosen for market size, liquidity, and industry group representation. It is a market value weighted index with each stock’s weight in the Index proportionate to its market value.
S&P Midcap 400 Index: The S&P Midcap 400 Index is a capitalization-weighted index measuring the performance of the mid-range sector of the U.S. stock market, and represents approximately 7% of the total market value of U.S. equities. Companies in the Index fall between the S&P 500 Index and the S&P SmallCap 600 Index in size: between $1-4 billion.
S&P Small-Cap 600 Index: The S&P SmallCap 600 Index consists of 600 domestic stocks chosen for market size, liquidity (bid-asked spread, ownership, share turnover and number of no trade days) and industry group representation. It is a market value-weighted index (stock price times the number of shares outstanding), with each stock’s weight in the index proportionate to its market value.
MSCI World Index: The MSCI World Index is a free float-adjusted market capitalization index that is designed to measure global developed market equity performance.
MSCI EAFE® Index: The MSCI EAFE Index is designed to represent the performance of large and mid-cap securities across 21 developed markets, including countries in Europe, Australasia and the Far East, excluding the U.S. and Canada.
Bloomberg Barclays U.S. Aggregate Bond Index: Bloomberg Barclays U.S. Aggregate Bond Index is a broad-based measure of the investment grade, US dollar-denominated, fixed-rate taxable bond market.
NASDAQ Composite Index: The NASDAQ Composite Index measures the market value of all domestic and foreign common stocks, representing a wide array of more than 5,000 companies, listed on the NASDAQ Stock Market.
Russell 2000® Index: The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index, which represents
Technical analysis is only one form of analysis. Investors should also consider the merits of Fundamental and Quantitative analysis when making investment decision. Technical analysis is based on the study of historical price movements and past trend patterns. There is no assurance that these movements or trends can or will be duplicated in the future.
Stocks offer long-term growth potential, but may fluctuate more and provide less current income than other investments. An investment in the stock market should be made with an understanding of the risks associated with common stocks, including market fluctuations.
Investing in foreign securities presents certain risks not associated with domestic investments, such as currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility.
Investments in fixed-income securities are subject to market, interest rate, credit and other risks. Bond prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in the decline of the bond’s price. Credit risk is the risk that the issuer will default on payments of interest and/or principal. The risk is heightened in lower rate bonds. If sold prior to maturity, fixed income securities are subject to market risk. All fixed income investments may be worth less than their original cost upon redemption or maturity.
Investing in commodities is not suitable for all investors. The commodities markets are considered speculative, carry substantial risks, and have experienced periods of extreme volatility. Investments in commodities may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular industry or commodity. Exposure to the commodities markets may subject an investment to greater share price volatility than an investment in traditional equity or debt securities. The prices of various commodities may fluctuate based on numerous factors including changes in supply and demand relationships, weather and acts of nature, agricultural conditions, international trade conditions, fiscal monetary and exchange control programs, domestic and foreign political and economic events and policies, and changes in interest rates or sectors affecting a particular industry or commodity. Products that invest in commodities may employ more complex strategies which may expose investors to additional risks, including futures roll yield risk.
Investment products and services are offered through Wells Fargo Advisors Financial Network, LLC (WFAFN), Member SIPC, a registered broker-dealer and a separate non-bank affiliate of Wells Fargo & Company. Any other referenced entity is a separate entity from WFAFN.
Robert I Cahill, Managing Partner Rob.Cahill@wfafinet.com
Jeffrey T. Bogert, Partner
Jonathan D. Soden, Partner Jon.Soden@wfafinet.com
Robert Sweeney, Financial Advisor Bob.Sweeney@wfafinet.com
Jay Knight, Associate Financial Advisor Jay.Knight@wfafinet.com