By Ryan O’Donnell, CFP® and Mike O’Donnell, CFP®
Key Takeaways
We’ve finally seen some optimism in the markets and economy.
But now is not the time to stray from your disciplined approach to saving, spending and investing.
A well-constructed long-term plan will already have bear markets, recessions and outsize volatility baked in. Stick to your plan and you’ll be fine.
As we write this post, the S&P 500 index is up nearly 11% from its mid-October low. Despite one of the worst starts to a year for stocks and bonds since the Great Depression, equities are “only” down about 15% for 2022. What’s more, the last three monthly inflation readings have been consistently “less bad” and most of the uncertainty leading up to the mid-term elections seems to be in the rearview mirror. That generally bodes well for stocks in the near-term as fourth quarter returns following midterm elections historically average +6.5% after averaging less than 1% on average pre-election (see chart below).
On Thanksgiving eve, the Fed dished out a few more dollops of optimism when it released the minutes of its early November policy meeting. Those minutes indicated that the majority of Fed policy makers believe that “it would soon be appropriate” to dial back the pace of interest-rate increases in 2023 and that the size of those rate increases would likely be smaller than the 75-basis point moves we’ve endured in 2022.
Directionally that’s a good sign, but it doesn’t mean to go out and buy stocks, real estate and other risk assets with abandon – or start spending like drunken sailors on exotic vacations and luxury goods – if those big-ticket items are not already in the cash flow plan we created for you.
As poet Robert Lowell would say: “The light you see at the end of the tunnel is probably the light from an oncoming train.”
Analysts are projecting a 4th quarter decline in corporate earnings and a U.S. recession remains very likely in 2023. Estimates of a recession range from about 50/50 (CNBC Fed Survey), to 65% (Bankrate), to virtually certain (Conference Board and Bloomberg Economics).
Supporting those estimates is the fact that we had an inverted yield curve in October. An inversion occurs when yields on short-term (3-month) treasuries are actually higher than yields on longer-term 10-year treasuries. While an inverted yield curve doesn’t guarantee that a recession will follow, the inverted yield curve HAS preceded EVERY recession in the U.S. since World War II (see below). And while most major asset classes post positive returns following a yield curve inversion, those returns are not robust enough to keep up with today’s inflation (see below).
Bear markets and recessions
Since the 1900s, the US economy has only managed to avoid a recession 30% of the time when a bear market has occurred. Bear markets (meaning stocks are down 20% from a recent high) are significantly longer (24 months vs. 8 months) and more severe (-40% vs. -28%) when they are accompanied by a recession (see chart below).
In addition to inflation and interest rates, there are two other significant drags on the economy and financial markets: COVID and the Russia-Ukraine conflict.
COVID-19. While life has more or less returned to normal in the U.S., COVID is stalling the Chinese economy significantly, due to that country’s frequent shutdown of cities as part of its “zero COVID” policy. Such shutdowns can be disruptive to the global supply chain for certain goods.
Russia-Ukraine war. One of the most unpredictable variables is the war in Eastern Europe with economic sanctions acting as a primary weapon used by western nations opposed to Russia’s actions. Higher commodity prices are another consequence of the war – think gasoline, diesel and heating oil prices -- which could also dampen global economic growth and keep prices elevated. That in turn could ignite more Fed rate hikes.
Whether or not we enter a recession, just know that markets have shown a remarkable ability to recover from market downturns over the years. As mentioned earlier, 2022 is one of the few calendar years in the past half-century in which stocks and bonds have been in bear market simultaneously. But even after accounting for that downdraft, the S&P 500 is still up by about 11% since Thanksgiving of 2020. The index is up about 27% from Thanksgiving 2019, three years ago, and by about 52% from Thanksgiving 2017, five years ago. That translates into annualized returns of +5.2%, +8.5% and +8.8%, respectively, very close to its long-time historical average of 8% to 10%.
Conclusion
Enjoy time with family as we head into the Holidays. As mentioned early, our clients’ long-term plans already have extreme market volatility and occasional bear markets built into their long-term assumptions. There’s no price tag on that kind of peace of mind. We are happy to discuss any questions you may have about your portfolio or retirement plan during these uncertain times. Please don’t hesitate to reach out.
