Last October, I wrote about the need to be prepared for typical fourth quarter volatility. Well, it looks like it was postponed until 2022 and all crammed into January. As I write this, the market is continuing its sharp selloff which has been led by the more speculative areas of the market. I would say the current correction is not too much of a surprise after the fairly meteoric rise from the March 2020 Covid-induced, panic lows without much of an interruption along the way. I have a few thoughts that I’d like to share about current conditions and then get to my big prediction.
Stocks – The “Bear” Case
As usual, there are many, many catalysts that can be cited as possible triggers for the market to decline (further). Here are just a few to mention:
- Inflation. This seems to be the big headline story (at least it was a few days ago in this dizzyingly changing news cycle). Some of the readings have been the worst in over 40 years, dating all the way back to the inflationary peaks of the late 1970s/early 1980s.
- High Valuations. By many different barometers, the U.S. stock market is priced at or near some of the highest levels in history. One that is often cited is the so-called “Buffett Indicator” that compares the total value of the stock market to the total value of the U.S. GDP (economy).
- Rising U.S. Interest Rates. The Federal Reserve has indicated that they plan to reverse from their super-easy, pandemic-related policies to tighter ones by raising interest rates and switching from quantitative easing to quantitative tightening. The market has anticipated up to four rate hikes in 2022 by the Fed as evidenced by the very sharp long-term interest rate rise to start the year.
- Geopolitical Risks. As I write this, the markets seem to be suddenly reacting to the Russian military build-up on the Ukrainian border and NATO’s reactions.
- Covid’s Continued Impact. The world’s economies continue to be severely impacted by the pandemic in so many ways. While the Omicron variant has been less lethal than previous variants, it has been so infectious that it has kept many businesses hamstrung to get healthy employees.
Stocks – The “Bull” Case
As I have said before, the justifications for why the market should decline always seem persuasive and intelligent. However, the truth is that the U.S. stock markets go up more than they go down and have always gone higher to new highs over extended time frames. While this might not sound nearly as persuasive and a bit simplistic, our most successful investors know that this is all that really matters and that maintaining this long-term optimism is what allows them “to keep their head while all around them others are losing theirs” as they buy when others are panicking and selling.
Nonetheless, there may be some other good reasons to be bullish right now:
- Economic Growth. The world’s economies have benefited from the monetary and fiscal stimulus that was unleashed in response to the pandemic. While the service sector has struggled with the shutdowns, etc., the manufacturing sector has soared. In fact, the U.S. unemployment rate has fallen below 4% (3.9% in December 2021) much, much more quickly than expected.
- Inflation Peaking? Much of the inflation surge has been triggered by the pandemic. Certainly, a big piece has been the supply chain challenges that have led to shortages and temporarily higher prices. We would expect that supply chains continue to improve in stops and starts as the world continues to adapt to functioning with the pandemic and/or the health situation improves.
- Not so High Valuations. Admittedly, on a long-term basis, valuations are still relatively high. However, the recent sharp retreat in stock prices has moderated some metrics. Also, as earnings and economic growth continue to increase even if the market goes sideways for a while, it will get cheaper. For example, a popular valuation metric is the Price-earnings (PE) ratio which takes the price of a security and divides it by its earnings (per share). Either a price decline or an earnings increase results in lower (cheaper) values.
- Rising Interest Rates – Not So Fast. The Fed has historically reacted to the stock market in deciding how tight or how easy policy should be. Since the stock market has been considered a leading indicator of the economy, this does make some sense that it would be a factor in their decision-making. If inflation does indeed settle back and stocks continue to decline, it would be hard for me to see the Fed tightening as aggressively as they’ve laid out in their plans.
- Inevitable. As I’ve said before, “the short-term declines are always temporary, while the long-term advance is permanent.” I still believe, as I said during the Global Financial Crisis, that I will live to see the Dow at 100,000. It’s just normal compound returns and me hanging around long enough.
I’m sure that you are on the edge of your seat waiting to hear what I predict, but first… I have to admit that the longer I am in this business, the more deeply I realize that nobody can predict short-term markets with any consistent accuracy. It’s just not possible and is a really lousy basis in which to invest, and I would never invest my or others’ portfolios based on market opinions.
So here is my prediction:
Those people who:
- Tie their investment strategies to their long-term financial plans
- Own diversified portfolios with specific allocation targets
- Keep costs down
- Don’t panic
- Take advantage of volatility by periodically rebalancing
will do just fine and can enjoy their lives without worrying about the market! They can turn off the news, get outside, read a good book, or (like me) fret about how well the Bears’ next football coach will do (talk about worrying about things I can’t control)!