To date, 2022 has been a bad year for the stock market. As long-term investors, this is the wild ride we signed up for.
Listen to the Wild Ride in Podcast Form
We like to think that we are immune from the kind of worry and distress that befalls so many investors in the tough times. We simply imagine the stock market down 20-30% in a world where everything else is the same. But in the real world, everything else is not the same.
The Wild Ride: Making Money is Easy. Losing Money is Hard.
I’ve been asked many times the details of my favorite investing strategy, or what I think about this or that stock. And there seems to be a high correlation between a hot market and the number of these inquiries I receive.
Conversely, it is rare to be asked about the emotions and psychology of investing. I can’t think of a single email or message asking about methods for keeping cool when the entire column of stock tickers is flashing red and every other news headline warns of the next big crash.
We like to think that we are immune from the kind of worry and distress that befalls so many investors in the tough times. We simply imagine the stock market down 20-30% in a world where everything else is the same. But in the real world, everything else is not the same. People are losing jobs, companies or entire industries might be crumbling, or in the case of the spring of 2020, a new and deadly virus might be spreading rapidly around the globe. Almost by definition, uncertainty is the emotion of the day.
Imagining losing money and actually seeing it happen, on paper at least, are two very different cognitive states. We can’t always envision the wild ride.
Bear Markets Are Normal
It is true that corrections, bear markets, and even recessions are normal and arguably healthy components of a growing economy, loosely synonymous with the forest fire of the natural world.
Once every five or ten years, markets and economies get a bit gummed up in big ways by inefficiencies or overzealous hype for a single sector (i.e., internet companies in the dot-com bust and real estate in the Great Recession).
Periods of contraction in the stock market or economy are usually the impetus to break these unsustainable growth cycles, forcing new behaviors within the market from all stakeholders. Sometimes new growth cycles are brought on by changes in fiscal policy by the government. These changes might be minor, such as slight adjustments to interest rates by the Federal Reserve, or historic in nature, such as the relief packages passed during the scariest moments of the 2008 financial collapse and the global meltdown following the arrival of the Covid pandemic.
Just like with your training, if you keep campusing when your elbows hurt, your elbows won’t get better. Your elbows are telling you that it is time to make a change. Ignore those signals long enough, ala the sub-prime mortgage lending practices of the early 2000s, and the problem will persist to a level beyond simple intervention, causing irreparable harm and a very long recovery.
We’re not even in a bear market, but you’d never guess it from watching the news.
Where Are We in the Stock Market Today?
As of market close on Friday May 13, the S&P 500 index settled at 4,023. The all-time high was 4,796 at close on January 3, 2022. The distinction of “all-time high” sounds cool and important but is actually a very common achievement. For instance, the previous all-time high was just three trading days prior, on December 29, 2021.
A bear market, arbitrarily defined as a 20% drop from recent highs, would occur if the market drops below 3,837 points. So, despite all the dread, uncertainty, and hand-wringing of late, the market is only down 16% from recent highs.
We’re not even in a bear market, but you’d never guess it from watching the news. You’ll hear fantastic, creative, and attention-grabbing headlines, such as, “stocks had their worst day since June!,” or “stocks at the lowest level since April of 2021!”
GASP!! Remember how damn excited we were to have the stock market crushing it at around 4,000 points in April of 2021? So what if we’ve taken a little backslide?! Nothing in nature, markets, or human behavior follows uninterrupted paths of pure growth. This is just another slightly unstable and slightly uncertain period in history, much like so many before it.
Here are some facts from the study of markets:
1. Bear markets (again, where stocks fall 20% from recent highs) occur, on average, every 3.6 years.
2. Based on this average frequency, an investor who plays the game for 50 years can expect to invest through 14 bear markets. How many notches do you have in your belt?
3. Bear markets do not necessarily walk hand-in-hand with recessions. Since 1929 there have been 26 bear markets, but only 15 recessions.
4. The worst bear market in history occurred during the Great Depression. The Dow Jones Industrial Average fell an underwear-staining 89% over a three-year period. Earning the well-deserved silver medal, we fondly recall the Great Recession and the shocking headlines of the 2008 financial crisis, where the S&P 500 fell over 50% from the fall of 2007 to the spring of 2009. More recently, the S&P 500 fell over 30% from February – March of 2020 during the arrival of the Covid pandemic, a shocking rate of decline.
5. Some good news: stocks are on the rise (hitting new highs) 78% of the time.
(Sources: Hartford Funds and Investopedia)
Why Are Stocks Falling Now?
In short, stocks are falling as an emotional response to persistent inflation and the Federal Reserve’s response to said inflation, which involves raising interest rates.
Many fear that aggressive changes in interest rates will slow the economy, making it harder for individuals and businesses to borrow, forcing the economy into recession. However, inflation persists due to imbalances in supply and demand (high demand, low supply), so hampering the ability to borrow will theoretically lower demand and enable supply to equilibrate.
For instance, as the Fed rate changes have been announced, we’ve seen the red-hot housing demand start to dwindle as mortgage rates begin to creep quickly northward from historical lows, under 3% in some cases.
What we must understand is that prior to these changes, the Federal Reserve lowered interest rates to near 0% to help stimulate the economy during the frightening initial moments of the pandemic.
When interest rates are near 0%, there is nowhere to go if the economy starts to contract for other reasons. It’s a fight with at least one arm tied behind your back against a deranged lunatic on PCP who won’t stop kicking. This is not a place we want to be for long, so interest rates had to be raised. We can argue in the margins about the timing or rate of change for the interest rate adjustments, but sitting at very low interest rate levels is a fragile and vulnerable state for an economy.
How is the economy doing, anyway?
Fair warning: I’m not an economist or a financial professional. I’m a former geologist who hasn’t worked as such for 2.5 years. But hey, these indicators are closely watched by those who are economists, and I can have a little fun. Hollar in the comments if I’m wrong, and email me if I’m really wrong.
Unemployment
The employment market is at 99% of pre-pandemic figures, which is fantastic.
Gross Domestic Product (GDP)
GDP decreased at an annual rate of 1.4% in Q1 of 2022, down from the strong increase of 6.9% seen in Q4 of 2021. Why? The Omicron Covid variant screwed up an otherwise strong growth trend observed since Q2 of 2020. See it here.
Inflation
It sucks. We know it sucks.
Consumer Sentiment Index
This is how the people are feeling. The CSI fell 9.4% in May of 2022, down 28.7% year-over-year (charts here). Basically, inflation hurts everyone. The pervasive problem of inflation contrasts starkly with a garden-variety economic downturn, which affects segments of the population much more strongly than others. Inflation affects everyone to some degree.
Monthly Sales for Retail and Food Services
Crushing it. People are spending at all-time high levels. When people spend more, companies tend to perform better. Despite low consumer sentiment, Americans, on average, have more cash than pre-pandemic levels. Some of this higher spending is indeed related to inflation, but in general Americans are out and about, spending at higher levels in spite of an otherwise grumpy take on the economy. Monthly retail trade data can be found here.
Financial Stress Index
The St. Louis Fed has created a financial stress index that captures key measures including interest rates, yield spreads, and various other indicators. According to this index, the economy is experiencing below-average financial stress, the lowest levels since this metric was introduced in late 1993. More on this analysis can be found here.
The Bottom Line: It Will Always Be a Wild Ride
So, despite a few mixed signals mostly related to Covid surges and associated fallout (high consumer demand from increases in cash savings, supply chain issues, etc.), the economy is really not in bad shape at all.
Honestly, considering the beating we’ve all taken over the last 2.5 years, I’m actually surprised we’re not licking more wounds. How the general public feels about the economy, especially as it relates to inflation, is another matter.
In essence, the economy appears to be functioning better than we think it is. For now, at least. No one has a magic crystal ball.
What We’re Doing with Our Money
I can’t give advice, but here is what we would do or are doing with our money.
As Investors
If I were still working my standard W2 job, I’d be doing what I always did…buying.
I’d buy stocks through my pre-designed asset allocation automatically through my workplace retirement plans with each paycheck. Any additional surplus would be set to automatically contribute to downstream accounts, including a brokerage account. We did this rigmarole every single month, taking our brains out of it. This process, known as dollar-cost averaging, is a method used to maximize time in the market through a regular titration of small investments.
Remember, it’s time in the market, not timing the market.
If this wild ride feels like a bit too much, reminiscent of that white-knuckle, B-grade horseback ride from last summer in Montana, it might be time to reconsider your asset allocation. Sure, an asset allocation of 100% stocks captures 100% of the gains, but also 100% of the losses.
Because we now have some income coming in (see below), we will contribute the max allowable to an HSA. Within the HSA, we invest all of those funds as part of our long-term healthcare plan.
As “Retirees”
Throughout 2021, neither my wife or I worked a standard W2 job. That changed earlier this year, when my wife returned to her former employer for a 20-hour/week remote contracting gig. With that said, we are delighted to have her income to offset our need to sell shares. We would likely be fine either way, as our plan to maintain a low withdrawal rate (<3.5%) means we don’t have any pressure to reduce spending during this market drawdown, even without supplemental income.
As People
Honestly, this is why I write and talk about this stuff. There are far too many misperceptions and unchecked, dopamine-laden emotions around money.
Do your fellow man a favor and help explain some simple fundamentals around money. Here, I’ll help with a rough guide that I use in my own life:
1. Spend freely on things or experiences that enhance the value of life. Limit or eliminate all other spending.
2. Invest savings in ways that generate sustainable returns. We prefer passive investing with index funds, but others are drawn to more active forms of investment, such as real estate or business creation.
3. If pursuing the passive index fund route, invest often and regularly, avoiding all temptation to sell or buy based on current events.
4. Do not sell until funds are needed to sustain your life.
5. Pay less attention to the news, especially in short-form. A period of 15-30 minutes per day is more than adequate to be an informed citizen. If you are interested in certain topics, consume long-form publications with opposing viewpoints. This kind of content is far more likely to capture the nuance of most issues and isn’t engineered to produce an emotional response for virality.
What do you think?
How are you guys feeling about the stock market and economy? Is this another passing phase or a warning of worse days to come? How are you handling the wild ride?