“History doesn’t repeat itself, but it rhymes.” – Mark Twain (is often reputed to say)
“Those who cannot change their minds cannot change anything.” – George Bernard Shaw
Really bad things have happened in the markets in the month of October. This year, that was not the case. In fact, October was quite the month of performance, as almost all the equity markets we track produced robust positive returns. The exception? Emerging markets. After a few months of backtracking, the CRB Commodities Index was up more than 2 ½ percent while bonds and the dollar were down for the month.
All data as of 11/01/2022, 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.]
We wanted to start this month out with an updated look at what we believe is the most important chart for the stock market. As we know, the stock market is not isolated from other markets. Just the opposite – performance is heavily influenced by what is happening in other financial markets.
Chart #1 shows the performance of the S&P 500, the US Dollar Index, and the 2-Year Treasury Yield. Last month we took note of how the stock market has moved lower as the dollar strengthened and yields increased. We took note of what looked to be a possible bottoming pattern and reversal for the stock index.
So far so good!!! In October the S&P 500 was up 6%. At the same time, the dollar moved sideways and yields continued higher.
Clearly the stock market has a long way to go, and we are not in a bullish scenario by any stretch of the imagination. There is still a lot that can go wrong. The Federal Reserve Board continues to increase short term Interest rates. The dollar hasn’t continued higher, but it hasn’t reversed.
No longer bearish but not bullish on the markets it would be best to call us optimistic. Optimistic that the worst could be behind us with better times ahead.
Maybe the Second Most Important Chart for the Stock Market
Having been around the world of investments for longer than we care to admit, we think we have a real understanding how the past can help us understand the future. Markets work in cycles both big and small. For investors (not speculators), short-term patterns are more like “market noise,” or simple daily gyrations. The bigger patterns can give us some better insight into valuable trends.
Today we want to take a look at the parallels between with what is happening today with what we saw happening some 20+ years ago. Specifically, we believe the technology-heavy NASDAQ of today is looking similar to the index at the start of the 21st century.
Chart #2 is a weekly chart of the NASDAQ from the start of 1998 through the end of 2002. Chart #3 is a weekly chart of the NASDQ from mid-2019 to today. On both charts we see a sizable bull market run that hits a peak, drops in price, attempts to rally but fails. In the case of the early 2000s the carnage continued for almost three years. The current downtrend has been with us for about a year.
We bring this to your attention for a number of reasons. First and foremost, it’s a cautionary tale. Looking back at what is now commonly referred to as the Tech Wreck, it is plain to see that many of the technology stocks at the time were either incredibly overvalued, or were companies without a real business plan. In the years preceding the crash, seemingly anything with a “dot com” in its name was able to raise capital by going public.
Many technology companies in today’s NASDAQ, in our opinion, were once again priced at extreme valuations at the start of the year. Yet there are a number of differences between 2000-2002 and today. First and foremost, the largest companies in the index by market capitalization are mature companies with proven business models. There were also some newer technology companies that became market favorites during COVID lockdown as they had products that shined during that time period. Add in record low interest rates to this environment and the big run up makes sense.
With overall valuations stretched beyond what we believe is reasonable some kind of price correction was going to happen at some point. This time around the return to more normalized valuations has been turbocharged by the very aggressive interest rate increases from The Federal Reserve Board (The Fed).
Key Takeaway: Valuations eventually matter. Great companies are not always great investments.
Different Investments Philosophy for Different Times
When most of us think back to the late-1990s the focus is on technology companies. Small cap and mid cap stocks were all but forgotten. Same for value and international sectors. Asset allocation, many investors thought, was unnecessary. It was all tech, all the time.
Then the stock market peaked in March 2000 and everything changed. The neglected areas of the market held up well while the hot sector got destroyed (technical term). The investor who gave up on asset allocation for the hot sector did not do well.
Fast forward to current times and these same trends and thoughts have been prevalent among many. Today, the big question on asset allocation has been, is the 60/40 allocation dead? And this isn’t coming from some fringe area of the internet but from large investment firms like Goldman Sachs and JPMorgan as well as mainstream publications like US News & World Report and Kiplinger.
History doesn’t repeat but it sure does rhyme. We see a lot of what went down 20 years ago in today’s markets. Value stocks have been outperforming growth stocks for the past year (see chart #4). Smaller and mid-sized companies as well.
Yet, there are a number of key aspects of the current markets that are significantly different. Interest rates being the most notable.
Back in 2000 the 10-year Treasury Bond was yielding in the 6.5% range, coming down from well above 12% in the 1980s. The downtrend in rates continued before finally bottoming in early 2020. In contrast, at the start of 2022, the same 10-year Treasury Bond was yielding under 2%. Ten months later those same bonds have more than doubled in yield.
The world of technology stocks is also very different than it was 20 years ago. Back then, even the largest and most durable of companies by market capitalization in the NASDAQ were, how can we put this best … priced for perfection. That was absolutely with us this time around, but not nearly as widespread. This time has been a bit different.
This time around, the largest companies by market cap are some of the more profitable companies. This time around these companies are what we would considered great companies that have become overvalued. Not absurdly overvalued, just end of bull market, needs some time to allow earnings to catch up to price kind of overvalued.
Key Takeaway: History and perspective can be a good guide
A New Approach / A Timeless Approach
So, where are we going with all this? As much as markets stay the same, they change.
- Asset allocation, which has appeared dead to many, is very likely to work in an investment environment not dominated by a few companies and reasonable interest rates.
- TINA (“there is no alternative” to stocks), on the other hand, makes no sense in a world where bonds and cash alternatives pay what we consider reasonable interest rates.
- What worked in the immediate past isn’t necessarily what will work in the immediate future.
Key Takeaway: Every investment cycle has its lessons. The best investors can incorporate those lessons when charting a course for navigating the next investment cycle.
Big Investment Lessons with a Silver Lining
Bear markets periodically happen and they are never fun. This year has been a more miserable situation due to the fact that this bear market has extended into the bond market as well as the stock market.
One of the things we have always tried to do at Magellan Financial when evaluating investments for our clients is to ask fund managers what lessons they have learned from past market cycles. Every time we ask this question I get interesting responses. Some are expected, others are not. Always thought provoking.
The point is to have a better idea of how to invest for the future without forgetting about the past. This time around we have found three common themes that all come with silver linings:
Stocks & Bonds Can Fall at the Same Time – This is something that hasn’t happen in such a long time that it wasn’t necessarily something that was forgotten, more like not even considered. For decades a portfolio allocated with both stocks and bonds would generally hold up well in a bear market for stock. Typically, interest rates are cut to stimulate a poor economy, and a poor economic background usually comes with poor stock market returns. When interest rates are cut, the value of bonds will in general rise (It’s not quite this simple). The result is the bond side of the portfolio supports the overall returns, dampening the poor results for stocks.
This was turned on its head in 2022. Due to high inflation interest rates have rose quickly from historically low levels this year. At the same time, the stock market has sold off for a variety of reasons.
The silver lining for investors is that both cash (money markets and CDs) and bonds again are at historically normal levels again. The problem of low yields of the past 10-15 years is behind us. What we experienced this year is not likely to repeat in the coming years. The 60/40 Asset Allocation’s future, once again, looks bright.
Gold Isn’t Always the Best Inflation Hedge – I love the gold commercials that tell us gold is not only the best hedge for inflation, but also deflation. If you believe the commercials, all you need to own is gold. Well … there might be a better route. In 2022 gold and silver have both posted double- digit negative returns as inflation has posted the largest increases we have seen since the 1970s. Gold and Silver worked in the 1970s more because the US Dollar was losing strength vs. foreign currencies, not because of inflation.
Here we see two silver linings. First, Gold and Silver should do well when the strong US Dollar trend reverses itself. The other silver lining is that is history has provided us with what works to mitigate inflation’s negative effects on your investments – companies with pricing power as well as companies with powerful brands.
Calling Stock Market Tops & Bottoms is Tough – If you have been reading our market reports you know we don’t get into the game of calling tops or bottoms. When we think of markets, we prefer to think of risks – both positive risks and negative risks. Right now, for example, the stock market has been having a really bad year, with the S&P 500 down x% at the end of October. Can the market continue to go down from here? Yes. Is investing in the stock market more “risky” today vs. January 2, 2022? Not necessarily.
And that’s the silver lining. Historically, we know that the best returns come from market declines. Markets sell off from time to time. Never feels good, but sets up the patient investor for potentially good returns in the coming years.
Smart investing takes more than using past performance to choose your investment portfolio. Beyond your personal situation and goals, a portfolio should not be a set and forgotten, but designed and revisited for adjustments, with an understanding of the present and reasonable outlooks for the future.
Markets work in cycles. These cycles resemble the past but bring their own unique times. Essentially, we need to smartly speculate about what the future may bring based on current market conditions. And when those conditions change, subtle changes to one’s allocation may be necessary.
Bottom Line: Investing takes a lot of thought and is as much an art as it is a science.
On behalf of Magellan Financial we would like to thank you for taking the time out of your busy day to take in our thoughts and opinions. If you found this helpful, please forward it on to others. If you have any questions on the materials presented, would like to be added to our email list, or would like our help with your investments, we can be contacted at 610-437-5650 or via email.
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.
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.
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.