IT'S THE END OF THE WORLD AS WE KNOW IT
(And I feel fine)
By: Bart Stevens, CFP
It's safe to say that last week, we almost certainly witnessed one of the most surreal market performances of my 21-year career in financial services. It's both funny and disconcerting that this is not the first time I've said that in 2022, and I suspect it's not the last.
When the markets opened on Monday morning, they continued their downward arc from the week/month prior, dropping another -5% and looking like they were heading into freefall for several days leading up to Russia's invasion of Ukraine. Then, they somehow mounted a rally for the ages and pulled out of their tailspin in spectacular fashion to stage a surprise 5% rally as soon as the tanks began rolling across the border. When the NYSE market closing bell rang on Friday afternoon, it left virtually every American, all of Wall Street- and no one more than me- completely baffled.
No doubt, we are entering the middle (extra) innings of a Fourth Turning, and our bipolar markets seem to be perfectly aligning with what sometimes feels like our bipolar culture. Irrational, emotional, unpredictable and without any rhyme or reason. And most of all, accelerating- it feels like we're experiencing years of headlines condensed into months, leaving a lot of stress out, confused and irritable. Or maybe that's just me.
In its wake, the quantity and quality of change has created a level of collective social confusion, anxiety and emotion that is both unprecedented and seemingly doubling down year over year. Sometimes, it's hard to remember when things were ever really normal. Someone asked me last week when I thought this country had officially jumped the track, and neither of us could even begin to pinpoint the date nor event. I know one thing for certain, it happened well before the pandemic.
Financial markets are currently digesting the three main issues of the day: inflation, interest rates and war. As many recognize from past experience, financial markets are usually adept at recognizing and pricing in events both global and domestic, but what they HATE is surprises. And when they are surprised and/or lack clarity - either on short-term or medium-term events - they tend to fluctuate (translation: freak out) until they a new sense of equilibrium has been established. In the interim, it often manifests in a market drop.
When we do go through these inevitable drops, I get calls and emails. A lot of them. And they are of a decidedly more aggressive nature than when everything is up. My response is genuine and specific, but it usually follows a similar pattern. Before delving into the macro-economy, I always find it beneficial to review my client's situation as a baseline. After that, we usually transition into the macro-economics, because that's what the markets care about and that's what influences the traders who fundamentally drive the market most of the time. (There are times when the retail investor masses seem to exert more outsized influence, but they're rarely trading off fundamentals and usually working off emotion. Which is why so few ever make any real money in the long-term. In that way, the market feels like a 'rigged casino' to many of them.)
While you would think that we as a society would have had more of an appreciation for the impact of giving out enormous amounts of money printed out of thin air (often to people and corporations that don't truly need it), alas it seems that even in pseudo-sciences like economics, natural laws still apply. Namely that when you generate and distribute currency- particularly if it's unearned with human labor (i.e. a job) - many recipients are especially prone to spend it, do so recklessly and rather quickly. This phenomenon is not dissimilar to 'trust fund babies,' many inheritors, settlement beneficiaries and now many lottery winners (don't ask me how I know).
In fact, I'm pretty certain that 90% of Range Rover owners were born into, married into or inherited the wealth necessary to buy the vehicle (or are a realtor). These vehicles hover around $100K (before fees) and it's been rare to meet someone who actually worked the hours necessary to purchase one. (I suspect the voice in their head is probably more akin to, "he would have wanted me to enjoy this money...")
It's no surprise to learn that the Federal Reserve and our leaders in Washington DC know how fast money gets spent quite well. They and those like them are quite familiar with one of the more fascinating aspect of national finance, the "saver's paradox." (Also called the paradox of thrift):
an increase in autonomous saving leads to a decrease in aggregate demand and thus a decrease in gross output which will in turn lower total saving. The paradox is, narrowly speaking, that total saving may fall because of individuals' attempts to increase their saving, and, broadly speaking, that increase in saving may be harmful to an economy. The paradox of thrift is an example of the fallacy of composition, the idea that what is true of the parts must always be true of the whole. The narrow claim transparently contradicts the fallacy, and the broad one does so by implication, because while individual thrift is generally averred to be good for the individual, the paradox of thrift holds that collective thrift may be bad for the economy.
In short, the paradox of thrift suggests that what's good for the individual is often suboptimal for your country- i.e. saving money and living debt-free. Because of course if everyone did that, the economy would collapse overnight. On the other hand, if the majority of the populace spends everything they make (and a bit more) and carries too much bad debt, that will ultimately lead to ruin. This dynamic is not new, and has fueled our wildly successful capitalistic economy, allowing the United States to become the most powerful and prosperous country on the planet, and the system to lift hundreds of millions out of poverty. As a result, our economic leaders felt confident that when they gave out money, it would be saved by a few but spent by many. And that is what has happened in the wake of the pandemic shutdowns. Now it's not unusual for a new pickup truck to go for $70K, multiples more than the cost of your first home.
When I discus inflation with clients, I find that many mistakenly believe that it is “prices going up...” That's understandable and not inaccurate. But it's incomplete as the truth is that a more technical definition for inflation is “too much money chasing too few products…” When the government choose to make multiple rather large deposits directly into the bank accounts of almost every adult in America (PPP, stimmy checks and mini-stimmys disguised as childcare credits... even the secret and massive student loan forgiveness of the past two years) as compensation for shutting down the economy and causing people to lose their jobs, they apparently failed to consider that money is not wealth, it’s currency. As a result, you can't manufacture prosperity by simply adding to the currency supply.
Unfortunately, when you create and distribute fiat currency that is not backed by anything and not the result of WORK, it will hurt the economy and devalue said currency. And honestly, we've all gone along with it, I can't find anyone who declined their checks or gave them back to the government. I sometimes wonder if we've become too soft as a culture, and as a result trusted that our government knew what they were doing and assumed we needed it. Many perceive that they had been wronged by the universe and deserve compensation for that, which I fear demonstrates a disturbing lack of intelligence. I worry these people are being conditioned to expect government handouts for their daily sustenance, and now the country is going through a painful reckoning that seems surprising but should not be.
It’s inevitable that when you print money and manufacture ‘prosperity’ without the labor (a dirty word to some people) to back it up, everyone suffers. But the poor and middle class suffer the most because money printing has only ever helped the wealthy. This is similar to the impact of defunding the police, increasing the minimum wage and generational welfare- it always and only hurts the ones that it professes to help. But people with poor math backgrounds fall for this ruse every time and then seem surprised when the inevitable happens (crime rises, prices of goods rise higher than incomes and large swaths of people lose their self-respect and agency, respectively.) This is universally true EVERY SINGLE TIME. The universe (and facts) don’t care about our feelings, nor the delusional narratives of some of how we think the world should work. So it's going to take some time to work through all this period where the Fed will have to remove this money from the economy.
As mentioned above, there are usually two main variables in the inflation equation:
- An increase in the amount of currency, and
- A drop in products and services to buy.
When our leaders chose to shut down the economy for two years, they ignored (or possibly dismissed) the impact that this would have on productivity. You may remember from economics class that a country - and therefore an economy, and therefore financial markets - only rise in value due to two primary drivers: population and productivity. While it is true that border patrol numbers show new immigrants flooding into the country at a pace of ~ 200K/month, but that is not currently benefiting the population side this time because there are no jobs for them in a shutdown. In fact, we are spending massively to support them and the states that absorb them and this has actually become a net financial drain on society. If the government now exists to distribute the productivity of the working class to those who are not currently producing (unemployed, retired, sick, disabled, etc.), it needs to increase productivity, but that's not been happening. We've been going in the opposite direction. You know this because 101% of all businesses in America are hiring and desperate.
That just leaves productivity to carry the load and keep the equation positive. Unfortunately, closing businesses in 2020 due to the lockdown and threatening jobs as a way to enforce vaccines, forcing folks to stay home, paying them to binge-watch Netflix and day-trade on their Robinhood app, and telling them they are victims- has adversely impacted individual and collective productivity. The consequences of this will ripple through generations not unlike LBJ’s Great Society. But for now, we’re a country and economy that is at a major labor crossroads. If you’ve had a customer service (or a dozen) experience in the past year that blew your mind, then you understand what our response to the pandemic has done to our level of work ethic and collective professional intelligence. Our economy now resembles the DMV and it's going to take months (if not years) to recover and rebuild.
The good news is that although the Federal Reserve was wrong on their anticipation that this ensuing inflation was both manageable and "transitory," there is a good chance inflation will subside by the end of this year and our economy could start reaching pre-pandemic levels in certain sectors before 2023. The approaching November midterms may rebalance the Congress (not that it will function much better than when one party or the other controls both houses), put some of our elected leaders on notice, and it’s reasonable to assume that corporations will soon feel more confident about the future economic landscape, and begin producing the quantity of supplies necessary to meet the scorching demand that money printing and lockdowns has produced.
Until then, the financial markets are likely to be very choppy, as "the smart money" tries to read tea leaves, digest market conditions and determine how and when we can reach a level of economic equilibrium. Then they will begin investing again. I can’t claim to have prophetic powers or time the market, but it’s reasonable to assume we will see some relief by the end of the year. And since Wall Street looks out about 9-12 months in advance, you obviously don't want to be getting out of this market now.
This is an aspect of the financial markets that I admit concerns me greatly, as every recession of the past 80 years has been caused by interest rates, specifically following a period when the Fed finds itself behind the curve and reticent to raise rates to tame inflation but is forced to make the politically unpopular and financially deleterious decision to raise rates. It’s not just raising rates that causes recessions, it’s raising them too fast, as this chart shows (the grey lines are recessions, the blue line is the Fed Funds rate for the past 70 years):
In every recession, the Federal Reserve waits too long to raise rates. They are then forced to move too fast for the country to adjust, pushing the economy and markets over a cliff. EVERY SINGLE TIME. As you can see above, not every interest rate hike causes a recession, but every recession is preceded by an interest rate hike. No matter how many times they are found with their fingerprints on the murder weapon, it seems the Fed continues to commit the same crime over and over again. And it's frustrating that we never hold them accountable for their economic malfeasance because our country’s financial knowledge is just too low, our justice system too broken and the power of corporate finance too vast to achieve the justice they deserve.
This is a good news/bad news situation. On one hand, it’s disappointing that we allow the Fed to torture our economy, enrich the wealthy and exacerbate the wealth gap every market cycle. Many still believe that wealth inequality is fundamentally caused by racism, sexism, the patriarchy, the rich, climate change, roadways, astrology, the groundhog, Santa, etc. But the evidence does not support that. I can't blame the media- they're basically young adult fiction writers at this point. It's not a huge leap from Star Wars and Harry Potter to what I read on the main websites. I suspect many of them know the truth but that most are still in the end journalism majors and didn't have many classes on the STEM (science, technology, engineering and math) side of campus. As information has become free and commoditized, perhaps we should not be that surprised that the final product has dropped in quality so far. The New York Times and Washington Post's own balance sheets show they would not exist if not for the generosity of their largest financiers. They're certainly not subsisting on subscribers.
It’s equally upsetting that we could be entering a period of rate tightening that will be painful for every American and end in economic carnage many years (or decades) in the future if left unaddressed. The good news is that current interest rates are at zero, the lowest in several generations and a fraction of the rates suffered through by Baby Boomers in the late-70s and early-80s, before Fed Chairman Paul Volcker (the last effective chairman, in my opinion) made the courageous decision to hike rates hard and fast, pushing the country into the 1982-84 recession but setting America up for the great period of prosperity in world history.
The ensuing sustained drop in rates for the 40 years since 1982 has ushered in the run of economic prosperity unrivaled in human history, and one we all still enjoy today- I term it "American privilege." Because rates are so low now, and would have to rise much faster and higher than anticipated at present, I suspect we have a lot more time than most people think until facing a potentially dangerous interest-rate level that threatens to tank this economy. Last year, the Fed communicated through the major brokerage houses that they planned to raise rates four times in 2022 (each .25%). This would only bring rates to 1.0% by the end or 2022, still a historically low level and hardly disastrous to the economy. In fact, I believe we would benefit from higher rates for a plethora of reasons I will spare you!
However, one of the major disruptions of the past two months has been caused by "speculation" (again, the Fed communicating through their member banks) that they are considering raising more and faster than previously anticipated. In fact, there is even rumor they will raise them .50% in the March FOMC (Federal Open Market Committee) meeting. As markets are prone to do, many traders have already priced in this possibility, which is certainly contributing to the confusion and market instability. If the Fed is already having to adjust their plans from just a few months ago, it’s possible that they now recognize and are trying to get control of the inflation that they have created and allowed to fester. I speak to about a few dozen clients every day, and every single one has noticed or expressed concern about their grocery bill, the price of fuel, forgoing purchases and investments into the future, etc. It seems that complaining about the rising price of food / fuel / life has become ubiquitous, like talking about the weather. The Fed knows a lot, but the market knows best. Especially, the bond market.
So, while interest rates seem to be a long way away from serving as the catalyst for the next economic recession, until key market movers regain some confidence that the Fed has a clear grasp of the economic landscape, rates are likely to be another wildcard for the stock market. This will preset some incredible buying opportunities for those with the experience, fortitude and resources to take advantage of it, while others may be left behind wondering why things are unfolding as they are and uncertain how to respond.
Speaking of incompetence, by now, America is quasi-engaged in various capacities in another foreign conflict, pitting two flawed leaders- one a ruthless, power-hungry and ego driven tyrant (Vladimir Putin) and the other (President Biden) who has an almost unbroken 48-year track record of dramatic domestic and geopolitical blunders that have finally given our two adversaries, Russia and China, the confidence to initiate ambitious plans for expansion. It's important to mention that this isn’t political- I do not belong, adhere nor subscribe to any political party; but if one cannot recognize the proactive leadership mistakes made by this and previous presidential administrations that have exacerbated the three current above, then I am here to serve as a conduit for the universe to inform you that you may be consuming the wrong information.
After decades of humiliation and fear following the end of the Cold War, and now that the Olympics have concluded, Russia's observation following Afghanistan is that the time was right to annex former resource-rich territories that they each believe are rightfully theirs. It’s reasonable to assume that China may soon begin similar movements in Taiwan and parts of the South China Seas. If and how the U.S. responds to these twin incursions will lay the foundation for geopolitics for a generation. But given America’s dismal 0-10 record for winning wars outright over the past 75 years, it’s clear that Wall St. lacks confidence that we will be successful in either theater.
Some speculate that is why the market is up- Wall Street assumes may assume that this war will be over soon, and while Russia is trying to accumulate natural resources in a most-immoral fashion, the truth is that Ukraine only represents ~ 0.5% of global GDP. We aren't going to send many troops because they are not strategically important to the House of Saud (our primary foreign policy criteria for the past 40 years). Ukraine's closet link to the United States is that they once employed President Biden's crack-smoking son at about $1M in annual salary (although to be fair, that was cut in half the month following his departure from the Vice-President role in 2016.
Once again, there are two sides to every coin and the glass can be both half-empty and half full. I think it’s safe to say that all investors- and all Americans- recognize that we probably lack the skill, resources or motivation to become entangled in a battle and region that 99% of Americans could not have identified on a map last year. We all are pained by the lives that are at risk and may be lost on both sides of this conflict- it feels reckless, unnecessary and heart-breaking. And most of us tremble at the injustice of an invasion and the likelihood that this will not be the last country Russia attempts to bring back under the control of Moscow.
On the other hand, the market reaction to this week’s invasion suggests that investors see little immediate impact on the markets of an annexed Ukraine. Or perhaps they think Russia will be dealt with so harshly that they may retreat. While I’m always loath to diminish the horrific human aspect of war, or ignore the plight of the oppressed, it’s my job to interpret and translate market activity and responses to major events. And for now, it seems that neither matches the level of fearmongering being perpetuated by our leaders, our intelligence community and the corporate media. This is not a political statement; this is just the current state of affairs in our country. If Europe and NATO won’t fight this war, it’s simply unlikely that the U.S. voter nor their representatives have the stomach to support it either. As a result, Wall Street may be logically (albeit, coldly) pricing in a quick and comprehensive occupation of Ukraine. The outcome will slowly be priced in depending on the remarkable courage of the people of that country, and Russia will pay a heavy price.
Unfortunately, my crystal ball is in the shop and I cannot even begin to predict market movement in the short-term. While long-term trends are much easier to predict, trying to apply logic and reason to a marketplace of billions of investors operating with varying degrees of intelligence and emotional self-control is like trying to predict the weather in a year. What I do believe is that the United States is still the most attractive economy and market in the world.
Unlike other countries- and especially our neighbors to the north- we were quick to pivot when science (and more importantly, political science) suggested it was time. We went back to work earlier than almost anyone (outside of Scandinavia) and our federalism structure has allowed us to spotlight and copy the policies of more successful states while people voting with their feet punished less successful strategies. This is now reflected in the massive, generational migration patterns of the past two years. Despite its flaws, we still have the most dynamic and successful economic and social structure on the planet. There's not even a close second. China may be growing and will likely surpass us in time, but they ain't doing it off the back of innovation, freedom and capitalism. Russia is largely a one-trick pony with a shrinking population- likely the reason they are threatening their neighbors and trying to resurrect the old USSR footprint.
Right now, we have a lot of anxiety and confusion in the culture that has bled into the markets like a slow leak. We also have a glaring mismatch between supply and demand, exacerbated by government policies in sectors like energy and manufacturing. Auto manufacturers can’t make enough vehicles to satisfy demand. Mills can’t cut down enough trees and even if they could, they lack the number of trucks necessary to deliver them to the massive quantity of new homes being built in rural America bursting at the seams with new transplants.
There are still large bottlenecks of tanker ships sitting off the coast of Long Beach. Store shelves sit empty for weeks on end for the most random of products and most federal government employees are still working at home until April- more than two years after the pandemic began. And the gradual dismantling of our fossil fuel industry may have been a bit premature. The crisis in Ukraine and our continued reliance on (now, much more expensive) Russian oil is highlighting how the greatest threat to the planet may not be American energy independence. It may be the the opposite. But it's gonna take time for these truths to be uncovered and these imbalances to be reset.
Thank God we have the advantage of a (relatively) free country and (relatively) free market is that these supply chain strains will eventually relax, adjust and rebalance. It's likely going to take longer than the 17-minute attention span of many Americans who is susceptible to instant gratification. As mentioned previously, Wall St. is usually about 9-12 months ahead of our economy most of the time. Which means by the time corporate media declares the worst is behind us, and the average person feels more comfortable re-entering the stock market, it's likely to have already factored this in in the form of improved asset prices. (Translation: this too shall pass!)
All of this suggests that we are best served by maintaining the same strategy of success that has worked in all previous economic cycles:
- Buy quality instruments and ignore speculation (most crypto, NFTs, etc.)
- Diversify (across investment types, categories and sectors)
- Hold (don't sell into a correction)
- Act against emotion (do the opposite of what seems logical because the market is often irrational)
- Buy INTO the big market dips (because no bell goes off at the top nor bottom)
"Buying the dip" usually means adding new money into the market as it continues to go ‘on sale’ with increasingly cheaper and cheaper prices. I’m perhaps in the only business in the world where people want to pay full price and get upset when products go on sale. If your investment timeline exceeds next week (or year), then I would posit that you should actually be excited about lower prices- not only now, but for as long as possible. Is anyone out there celebrating the price of fuel and pickup trucks? In the securities business, they would be popping champagne bottles. Conversely, if the price of new vehicles dropped in half, car dealerships would look like H-E-B the day before an ice-storm. But in the securities business, when markets fall, even slightly, I get much more angry calls than enthusiastic ones, with people asking why their money has disappeared and what are we going to do about it.
In my experience, for far too many investors, even if they have no immediate plans to withdraw their money, still somehow need a herd of gullible investors to validate the price of their stocks simply to make themselves feel better. I understand the temptation, I really do.
Of course, everyone’s situation is different, so it would be impossible to promote a single solution to any market quandary for a specific client. But I know that it’s almost always folly to react when markets move rapidly, especially during corrections. In all my years in financial services, what I have noticed is that humans have an insatiable need to believe they are in control. That’s one reason they lose their minds when the market goes down, it spotlights that they have no control whatsoever over the inevitable and predictable short-term vicissitudes of the markets, and that short-circuits the wiring in their brain that causes them to make incredibly poor investment decisions in the fallout. They ALWAYS ponder, obsess and stress out over "all the better/ smarter/ more fun things that they could have done with that money." When they feel a loss of self-control, some go out and hoard toilet paper, because (presumably) if their credit card still works, then they are in control of their destiny. Every hoarding period (ice storms, economic crunches, Black Friday, etc.) is a fascinating study in irrational human psychology.
Investors often think they can time the market, despite:
- No evidence to support that (in their own life or with others), and
- market timing requires one to guess right twice: once when getting out of the market and then again when getting back in.
NO ONE has ever been able to do that successfully over the long-term. Warren Buffett has gotten close. Some can do it correctly once, but that’s like hitting the jackpot in Vegas on your first trip- it’s usually a curse. The media often anoints them an economic celebrity (whatever that is) and they get put on the air whenever the station thinks they have at least an idea of where the market is going to do next. They are almost never right again and go on to "predict 10 of the next 2 recessions."
My advice is to turn off the damn news. Seriously. Both sides. With ratings in freefall, and I can foresee very little beneficial value to consuming any news on a television, from any three-letter corporation or news source with a city/state/country in the title. If we’ve learned anything over the past five years, it’s that the media is no longer in the facts-business, they are mere propaganda. On both sides, it's getting embarrassing.
The truth is that if you believe that things are never going to get better in this country, then an argument can be made for selling all your investments (or at least adjusting them), getting out of the market and moving to cash. But if you really thought that it’s only downhill from here, you are probably dealing with some personal problems and life decisions that supersede what happens to your money. And sitting in cash is hardly a panacea, as it will immediately begin debasing about 10-15% per annum (using the true, pre-1980 inflation formula) per year. As I've written about many times before, cash is the only guaranteed loser each and every year. And that’s by design, folks. In 2022, cash is losing roughly a percent a month. Significant amounts of the currency in circulation was printed in the last two years. You'll soon discover why that is not a realistic long-term option.
Personally, I choose to bet on history, and it’s pretty clear that markets go up during times of global conflict, inflation is self-equalizing and eventually subsides, and rising interest rate are a healthy and normal aspect of any capitalistic economy. I’ve looked back and have never been able to find a reasonable time period (10 years or more) when the United States didn’t get better and produce higher standards of living for most people. I don’t think Ukraine is a bigger conflict than 9/11 and the War on Terror. Living in a country with a 1% Federal Funds rate is not even in the same ballpark as the Carter-era. And the less government involves itself in the economy, the better it generally performs outside of necessary regulation. Jobs will come back, goods will return to the shelves, demand will recover and then some, and America will continue to be an economic juggernaut.
At Stevens Wealth, most of our models have prudent balances of stock-market and non-market investments, and this is done purposely to leave a portion of the portfolio shielded from market gyrations, thereby allowing the more aggressive holdings to recover over sufficient timelines following corrections. This allows clients to use the safer positions to either a.) live off of in periods of economic duress, or b.) put into the market as it drops. Most of our clients have no/low debt positions, healthy emergency funds and a budget. If you can say that, then you can ride out periods of market volatility like the one we’re currently enduring.