By Ryan O’Donnell, CFP® and Mike O’Donnell, CFP®
Key Takeaways
Recency bias is the tendency to place too much emphasis on experiences that are freshest in your memory—even if they are not the most relevant or reliable.
Since stocks are a leading indicator of the economy, markets typically bottom out and start to rebound months before the end of a recession.
Ask your advisor to help you rebalance your portfolio as needed, especially if your life circumstances have changed.
Even after Fed Chairman Powell spooked the markets with his promise to continue raising interest rates for the foreseeable future, the major indices are still about 10% higher than they were in mid-June. Powell’s comments should not have surprised anyone since he has told us again and again and again that the Fed plans to continue raising rates by 50 to 75 basis points every few months into early 2023 until it sees this latest wave of inflation start to diminish.
So why were investors then so spooked by Powell’s hawkish comments? Because they let their guard down and thought that a slight improvement in the inflation rate this month might get the Fed to relax its rate hiking mandate. In behavioral finance we call that “Recency Bias” -- the tendency to place too much emphasis on experiences that are freshest in your memory—even if they are not the most relevant or reliable. The recent “less bad” inflation numbers on top of a mini rally in stocks since mid-June, had many thinking the worst was over.
It's not.
As most of our clients know, wishful thinking is not a strategy. Fed rate hikes (and cuts) are not a switch that can be flipped on and off. It takes a while for these policy changes to work their way through the system and that’s what we’re seeing in the form of volatility and uncertainty. NOTE: Our clients already have this volatility priced into their plans and they’ll come out of this downturn even stronger than before.
But what about a recession?
People keep asking us if we’re heading toward a recession, or perhaps already in one. As a long-term investor, it really shouldn’t matter. Much of the Fed’s concern about an overheated economy has to do with a stronger than expected labor market and a rebound in consumer confidence. You heard that right. Too many people working and consumers feeling better about things. That doesn’t sound like we’re on the brink of a real recession, let alone a Great Depression, does it?
Chances are, we’re already in a recession. But by the time it’s officially declared a “recession,” we’ll likely be out of it. But even if we’re not, don’t do anything rash with your financial plan. Markets often hold up quite well during recessionary periods and you don’t want to miss out on the eventual recovery.
Since stocks are a leading indicator of the economy, markets typically bottom out and start to rebound months before the end of a recession as the chart below shows. Just don’t sit on the sidelines waiting for the market to issue you an all-clear signal that it’s safe to get back in. By that time, it’s too late.
What’s more, the S&P 500 has actually posted positive returns in seven of the thirteen recession years since World War II, and the average decline in those recession years is only 1%. In fact, the market has been positive all but three times in the year following recessions, with an average gain of nearly 17%.
No one knows for sure whether the recent rally in stocks will last. But you might as well stay fully invested because no other asset class consistently helps you keep pace with inflation better than stocks. Stick with your plan and ask your trusted advisor to help you rebalance your portfolio as needed, especially if your life circumstances have changed recently.
So, when do we get a break from inflation, and hopefully end Fed rate hikes?
Consumers have also been making up for lost time in their spending on services, dining out and traveling, as Covid-19 restrictions subside.
As the Wall Street Journal reported recently, supply-chain disruptions are starting to ease but have also contributed to inflation. “Russia’s invasion of Ukraine, for instance, contributed to a run-up in wheat and corn prices that is making groceries more expensive. Energy prices have gone up sharply, though they have cooled recently. Truck drivers, seaport slots and warehouse spaces are all in short supply, leading to costly delays and rising shipping rates for goods,” the Journal added.
Also, since there are far fewer workers in the labor force than there would normally be, employees have the leverage to demand raises which typically get passed on to consumers in the form of higher prices.
Since the Fed considers inflation “Enemy No. 1,” it is aggressively raising rates to make borrowing more expensive and hopefully slow down the economy. These factors among others are driving up costs. Many economists believe inflation should start easing later this year or in the first half of 2023. Again, it will take some time for these shocks to work their way through the system.
But, when they do, we don’t want you to miss out on the next wave of prosperity. As the old saying goes: “Good luck happens when preparation meets opportunity.”
Conclusion
Remember, stocks are not valued based on what's happening today; they are valued based on what the market thinks their future cash flows will be. Investing is a long-term game. Always keep your guard and your eyes wide open.
We’re happy to discuss any questions you may have about your portfolio or retirement plan. Please don’t hesitate to reach out.
