Markets Are Stuck In Overreaction Mode
September Market Outlook
There is currently a lot of talk about a recession approaching by the end of this year and as a result, we have seen recent market selloffs as investors become worried about our economies future. The National Bureau of Economic Research (NBER) defines a recession as “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production and wholesale-retail sales.” The source of these recessionary concerns stem from The Federal Reserve, which is currently increasing interest rates to slow down economic growth and combat high inflation levels. They are specifically increasing the federal funds rate. The federal funds rate refers to the interest rate that banks charge other institutions for lending out excess cash. The federal funds rate is important because the rate can determine how much it costs for you to borrow from the bank in the form of interest rates. The main goal of the Federal Reserve right now is to reduce rampant inflation by increasing interest rates and slowing down economic growth.
Higher interest rates do not mean the economy suffer a major crash. An economic slowdown is necessary to ensure that price stability is maintained. Boston Federal Reserve President has recently said in a press conference that “history has shown that price stability is a precondition to achieving maximum employment over the medium and long term”. Therefore, short-term pain for consumers and businesses will be necessary to achieve the fed’s goal of 2% inflation. Many people within the Federal Reserve and outside experts believe that the damage to overall growth would be limited. In a recent press conference, the chairman of the Federal Reserve, Jerome Powell, stated that “Higher interest rates, slower growth, and a softening labor market are all painful for the public that we serve, but they’re not as painful as failing to restore price stability”. Making sure inflation can be controlled is painful for us as investors in the short term, but we believe it is necessary to foster a more stable future for long term investments.
Although many investors are becoming fearful of an imminent recession, economy and survey data have held up well. Healthy gains in employment and disposable personal income are fueling nominal consumer spending growth, and confidence in our economy has lifted. According to a credible source from Goldman Sachs, “The US economy has about a one in three chance of slipping into a mild recession by the middle of 2023”. A lot of economic experts are predicting a mild recession with only a limited increase in the unemployment rate of 1%. With economists and market experts predicting a shallow and mild recession, there is a good chance that this recession will not be nearly as painful as ones seen in the 1980s and 2007-2009.
More current evidence for a mild recession are unusually high level of job openings typically seen during a recession. This should dampen the recessionary effect of higher unemployment in the economy. Experts are also predicting that consumer spending will be higher than in past recessions. In other words, consumers may feel the effects of this recession much less than the recessions of the past. Another big reason to have optimism for the future is that there are many sectors in the economy that are currently growing and have room to normalize to their pre-pandemic levels, even during a recession. Due to the negative market effects we saw during the covid pandemic of 2020, sectors such as transportation services, tourism, and infrastructure were already negatively affected before the recent market selloff. Now that covid restrictions and have been lifted, these sectors have started recovering even among upcoming recession fears.
Randall Kroszner, former Federal Reserve governor, claims that “A U.S. recession this year or next is looking likely, but Americans can rest assured that the worst-case scenario of a ‘devastating early-1980s–type recession’ probably won’t come to pass”. The economic conditions of today are different from the past, therefore many experts are expecting the predicted recession to be very mild. A deep recession would only occur if inflation levels do not decline further by next year. The Federal Reserve would be forced to take even further action and increase interest rates more. Thankfully, this is highly unlikely as inflation has peaked and has been slowly declining after each inflation report.
To combat the predicted mild recession, Traditions Wealth Advisors has been researching new potential investment opportunities for you, our valued clients. We have been avoiding and trimming our clients’ holdings in volatile growth funds and have placed an emphasis on value funds. Dividend stocks also provide a cushion for a portfolio during a recessionary period. Fixed income investment opportunities continue to remain as a solid income generator during slowdowns. We also have been researching investment opportunities in the real estate market, and have added TIAA-CREF Direct Real Estate to most of our clients’ portfolios, which has produced positive gains while most other asset classes have been hit hard.
It is important as investors to not overreact to a recession and all the over-the-top news headlines. It is important to stay focused on long term investment goals and not make any decisions due to a short-term disruption.
While control of Congress may be at stake, do midterm elections have any effect on markets? To find out, we examined more than 90 years of data and found that the answer is yes, markets have behaved differently during midterm election years. Here are five things you need to know about investing in this political cycle:
1. The president’s party typically loses seats in Congress
Midterm elections occur at the midpoint of a presidential term and usually result in the president’s party losing ground in Congress. Over the past 22 midterm elections, the president’s party has lost an average 28 seats in the House of Representatives and four in the Senate. Only twice has the president’s party gained seats in both chambers. Why is this usually the case? First, supporters of the party not in power usually are more motivated to boost voter turnout. Also, the president’s approval rating typically dips during the first two years in office, which can influence swing voters.
Since losing seats is so common, it’s usually priced into the markets early in the year. However, the extent of a political power shift — and the resulting policy impacts — remain unclear until later in the year, which can explain other trends we’ve uncovered.
2. Market returns tend to be muted until later in midterm years
Our analysis of returns for the S&P 500 Index since 1931 revealed that the path of stocks throughout midterm election years differs noticeably compared to all other years.
Since markets typically rise over long periods of time, the average stock movement during an average year should steadily increase. We found that in the first several months of years with a midterm election, stocks have tended to have lower average returns and often gained little ground until shortly before the election.
Markets don’t like uncertainty — and that adage seems to apply here. Earlier in the year there is less certainty about the election’s outcome and impact. But markets have tended to rally in the weeks before an election, and they have continued to rise after the polls close. So far, 2022 has been another example of a midterm election year with lackluster returns, although the impact of politics has been minimal compared to that of inflation and rising rates.
Despite the uncertainty, investors shouldn’t sit on the sidelines or try to time the market. The path of stocks varies greatly each election cycle, and the overall long-term trend of markets has been positive.
3. Midterm election years have had higher volatility
Elections can be tough on the nerves. Candidates often draw attention to the country’s problems, and campaigns regularly amplify negative messages. Policy proposals may be unclear and often target specific industries or companies.
It may come as no surprise then that market volatility is higher in midterm election years, especially in the weeks leading up to Election Day. Since 1970, midterm years have a median standard deviation of returns of nearly 16%, compared with 13% in all other years.
4. Market returns after midterm elections have been strong
The silver lining for investors is that markets have tended to rebound strongly in subsequent months, and the rally that has often started shortly before Election Day hasn’t been just a short-term blip. Above-average returns have been typical for the full year following the election cycle. Since 1950, the average one-year return following a midterm election was 15%. That’s more than twice the return of all other years during a similar period. Of course every cycle is different, and elections are just one of many factors influencing market returns. For example, over the next year investors will need to weigh the impacts of a potential U.S. recession and global economic and geopolitical concerns
5. Stocks have done well regardless of the makeup of Washington
There’s nothing wrong with wanting your preferred candidate to win, but investors can run into trouble if they place too much importance on election results. That’s because, historically, elections have had little impact on long-term investment returns. In 2020, many investors feared the “blue wave” scenario, or Democratic sweep. But despite these concerns, the S&P 500 rose 42% in the 14 months following the 2020 election (from November 4, 2020, through January 3, 2022). Going back to 1933, markets have averaged double-digit returns in all years that a single party controlled the White House and both chambers of Congress. This is just below the average gains in years with a split Congress, a scenario which many believe is a strong possibility this year. Even the “least good” outcome — when the president’s opposing party controls Congress — notched a solid 7.4% average price return.
What’s the bottom line for investors?
Midterm elections — and politics as a whole — generate a lot of noise and uncertainty. Even if elections spur higher volatility there is no need to fear them. The reality is that long-term equity returns come from the value of individual companies over time. Smart investors would be wise to look past the short-term highs and lows and maintain a long-term focus. For further questions about the markets and this article, please reach out to Traditions Wealth Advisors at 979-694-9100 or Brien@TraditionsWealthAdvisors.com
Source: Buchbinder, Chris. Miller, Matt. 8 September 2022. Can midterm elections move markets? 5 charts to watch. https://www.capitalgroup.com/ria/insights/articles/midterm-elections-markets-5-charts-sept-2022.html?sfid=504078533&cid=80828184&et_cid=80828184&cgsrc=SFMC&alias=B-btn-LP-MidtermElectionsMarkets
Stay the Course
It may be tempting to take money out of the stock market. Sticking to a long-term plan is usually best. It can be hard to stay the course. Acting on emotion or trying to anticipate the market’s direction can compromise a portfolio’s long-term return potential. In general, having an asset allocation aligned with the time horizon of an investor’s goals is the most prudent path. Staying the course takes patience and discipline and can be especially difficult during times of uncertainty. Investors with a healthy dose of equities in their portfolio are likely to benefit from the long-term growth potential of stocks since, over time, the magnitude of market gains has been significantly greater than that of losses. Of course, past performance cannot guarantee future results. Remaining invested through downturns and corrections may allow investors to take advantage of long-term growth potential.
While it may be challenging to stick with a long-term strategy, doing so means an investor could be well positioned to reap potential gains as the market recovers.
In times of market volatility, it’s impossible to know when it may end. Investors who feel a strategy change is in order could consider gradual adjustments. They could also wait until the volatility subsides to make wholesale shifts to their strategy. “These are challenging times for many people,” says Judith Ward, CFP® of T. Rowe Price. “If investors control the important things, such as how much to save and spend, and position their investments to balance this short-term volatility with longer-term growth, they can give themselves the best chance to achieve a comfortable retirement.”
Questions about your portfolio and staying the course article? Contact Brien@TraditionsWealthAdvisors.com
Source: T. Rowe Price. 25 July 2022. Personal Finance. https://www.troweprice.com/personal-investing/resources/insights/does-staying-the-course-still-make-sense.html?cid=PI_Single_Topic_NonSubscriber_ACC_PRE_EM_202207&bid=1046947328&PlacementGUID=em_PI_PI_Single_Topic_EM_NonSubscriber_202207-PI_Single_Topic_NonSubscriber_ACC_PRE_EM_202207_20220728&b2c-uber=u.4BDAB1C8-0F6B-9872-F733-7678B43EBF89
August Market Outlook
There is still a lot of uncertainty about the current economic environment, some economists are calling for a mild and shallow recession while others think it will be far more severe. However, we would like to keep all our clients updated on the most recent economic reports and our thoughts on the current data. The most recent jobs report from July was unexpectedly stronger than expected which gives off mixed signals for the current economic state of our nation. On the other hand, the inverted U.S. treasury yield curve among other leading economic indicators that have historically been harbingers of recession are showing pockets of weakness in the economy.
U.S. Stocks and Economy
July’s jobs report was undoubtedly hot with wages growing 5.2% year-over-year in addition to the economy adding 528,000 jobs. This boosted payrolls above their pre-Covid peak in February 2020. However, this report has two different points of view. Bulls were ecstatic to see these report numbers and viewed them as a sign of the economy strengthening. However, this goes against the Federal Reserve’s course of action for slowing down the economy. Adding many more jobs than analysts estimated means that the economy is still expanding which could tempt the Federal Reserve to continue implementing higher interest rate hikes. Meanwhile, leading economic indicators are not suggesting a strong backdrop for the labor market. As shown in the chart below, the Conference Board’s Leading Economic Index (LEI) has fallen by nearly 2% over the past 6 months. Excluding the Covid-19 pandemic, we have not seen the LEI stumble like this since August 2009. Similar declines are consistent with prior recessionary periods.
Fixed Income: Yield Curve Inversion
During the Fed’s campaign to tame high inflation, we have now seen the target range for the federal funds rate raised 4 times since the rate-hike cycle began in mid-March. The upper end of the range is now 2.5% compared to the starting level of 0.25%, making this one of the most rapid tightening cycles in the past 40 years. In September, the pace at which assets roll off the Fed’s balance sheet (quantitative tightening) is also set to accelerate. Although the annual inflation rate has come down slightly from 9.1% and flattened out at 8.5% and wage growth running at more than 5%, more interest rate hikes are expected. The current market pricing suggests investors expect a peak in the federal funds rate of 3.6% in the first quarter of 2023. Then there is an expected series of rate cuts that will bring the interest rate down to 3% by early 2024.
There is always a degree of uncertainty when trying to predict future interest rate hikes from the Fed and this outlook may be too optimistic in terms of the Fed’s actions. However, we’ve also seen recent inflationary pressures start to decrease. Commodity prices have dropped, inventories are rising relative to sales, the U.S. dollar is stronger, and global economic growth has been soft. Another response to the Fed’s rapid tightening cycle is an inverted yield curve, where short-term interest rates are higher than longer-term rates. By boosting short-term borrowing costs and reducing the liquidity available to the financial system, the Fed’s actions should slow economic growth and inflation down the road. An inverted yield curve has been a reliable sign of an impending recession in the past. However, not all 2-year/10-year inversions have led to recessions, but they all have resulted in some degree of economic slowdown.
Global Stocks and Economy
An inverted U.S. treasury curve hasn’t just been a negative sign for the U.S. economy historically, it has also argued for global recessions. While the high and rising risk of an economic recession may not be news to everybody, the yield curve could be signaling an earnings recession ahead. Although earnings held up well in the first half of the year, Wall Street analyst forecasts continue to point towards double-digit earnings growth over the next 12 months. This is a very unusual occurrence during an economic recession. Decreased earnings could cause stocks to pull back further than they appear now. High dividend paying stocks may continue to reward should the economy and earnings slow down. Alternatively, if earnings growth remains resilient as inflation begins to subside then stocks may recover. Especially for those with the brightest earnings growth prospects and lowest price-to-earnings ratios, which tend to be more prevalent in the stock markets of Europe and Japan.
It might be hard to remember, but only 2 years ago the pandemic started and doubts if it would ever end or a vaccine would ever be developed were on the minds of most people. Today, it is a much better place. Here are some reasons to stay optimistic in the current market environment.
1. Global supply chain pressures are easing
2. Commodity prices are on the decline
3. There are some bright spots in recent inflation data
4. Long-term US inflation expectations are becoming better anchored.
5. Positive economic signs have emerged in China.
6. COVID has improved in China.
7. When pessimism permeates markets, positive surprises can be more powerful.
Do you want more details on the above reasons? Find out more: Invesco.com
Welcome James Lane to the TWA team! As a Financial Analyst Intern, James's primary scope of analysis is ensuring that investments our clients hold are optimal given their risk level through diligent quantitative and qualitative research and assigning them buy, sell, and hold ratings. He engages in investment research and portfolio modeling to aid and support portfolio management decisions made by Brien and Sarah for the TWA clients.
James is from Austin, Texas and a current senior at Texas A&M University pursuing a bachelor’s degree in economics. In his free time he enjoys playing golf and watching Aggie football and baseball. James is also an avid outdoorsman. He will never pass up an opportunity to get out in nature whether that be swimming and hiking the creeks and trails of Austin or fly fishing and hunting all over Texas and other parts of the U.S.
Welcome to the team, Kendall!
'The traditions the school possess brought me to A&M' our new accounting intern shared with us in a recent interview. Class of 2023, Kendall is looking forward to applying and starting the PPA program this year. After graduation, she would like to move to Dallas to work for one of the Big 4 Accounting firms. Until graduation, Kendall is just enjoying summer time and likes to visit her family in Marble Falls. She especially loves her time with her 1 year old nephew. Just for fun we asked Kendall what her ultimate vacation would be? She said Greece for the gorgeous views and she would love to dive into the culture. Learn more about Kendall and her roll at Traditions Wealth Advisors, on our 'About' 'Our Team' tab.
July Market Outlook
What Is A Recession?
With current market conditions, many media outlets are calling for a recession or stating that we are already in a recession. There are many broad ways to define a recession, many economists say that a recession is two quarters in a row with negative GDP growth. However, this is debatable as there are many different opinions on what a recession is. My personal favorite is from a committee of experts at The National Bureau of Economic Research (NBER), a private non-profit research organization that focuses on understanding the U.S. economy. They define a recession as “a significant decline in economic activity that is spread across the economy and lasts more than a few months.” The NBER takes account of a number of monthly indicators such as employment, personal income, and industrial production, as well as quarterly GDP growth. Therefore, while negative GDP growth and recessions closely track each other, the NBER’s consideration of monthly indicators, particularly employment, means that the identification of a recession with two consecutive quarters of negative GDP growth does not always hold.
Latest Macroeconomic Update
Some of the top economists in the world have posted their thoughts on the current macroeconomic environment in the U.S. and abroad over the past week. Byron Wien who is Vice Chairman of Blackstone’s Private Wealth Solutions group stated that he believes that if we do go into a recession, it will be a short and shallow one. He believes that this recession will not resemble the recession of the Dot.com crash and the Great Recession between 2007-2009. Wien said that the difference between the current markets and these two particular recessions is that consumers and companies are in much better shape compared to the two previous recessions. Consumer savings have been built up over a sustained period of time and companies currently have strong balance sheets. Wien also stated that the two previous recessions were marked by extremes. There were extreme valuations of companies with no earnings in 2001 and excessive speculation in the housing market in 2008, with unemployment ticking up and inflationary pressure starting to ease, Wien doesn’t believe that this recession will be caused by an extreme.
Another economist that gave his recent macroeconomic outlook is Dr. David Kelly, Chief Global Strategist and Head of the Global Markets Insights Strategy Team for J.P. Morgan Asset Management. Dr. Kelly also believes there will be a shallow and lighter recession in the future, he also stated that this recession would be nowhere near the magnitude of the 2001 Dot.com recession and the Great Recession of 2007-2009. Dr. Kelly also believes that the markets have not bottomed out yet, as consumer sentiment is still very low, and inflation is still high but starting to decline.
The Fed also released its June Meeting Minutes, they reaffirmed their commitment to bringing down inflation with more rate hikes between 0.5%-0.75% in the upcoming meetings. They acknowledged that the policy tightening would likely come with a price, “participants recognized that policy firming could slow the pace of economic growth for a time, but they saw the return of inflation to 2% as critical to achieving maximum employment on a sustained basis.” The approach comes with the U.S. economy already on shaky ground. Gross Domestic Product (GDP) in the first quarter fell 1.6% and is on pace to decline 2.1% in the second quarter, according to an Atlanta Fed data tracker. Some people would view this as an official recession; however, it would be a historically shallow recession. The Fed officials also noted some reports of consumer sales slowing and businesses holding back on investments due to rising costs. The war in Ukraine, as well as supply chain bottlenecks and Covid lockdowns in China, were also a concern. Officials also penciled in a much bigger inflation surge than before, now anticipating headline personal consumption expenditures prices to jump 5.2% this year, compared to the 4.3% previous estimate. The meeting minutes also noted that after a series of rate hikes, the Fed would be well-positioned to evaluate the success of the moves before deciding whether to keep going. They said “more restrictive policy” could be implemented if inflation fails to come down.
Is A Recession Already Priced Into The Markets?
Equities have fallen so quickly, well ahead of profits, that equities have already factored in a recession. A broad range of data suggests recession risks in the U.S. are mounting. Economist Albert Edwards stated “The leading indicators look grim as well. For example, the Conference Board’s leading indicator fell for the third month in a row in May and that now makes 4 declines in the last 5 months. That is normally stuff of recession.”
Stocks also remain under selling pressure due to issues causing a repricing of valuations. These issues include surging inflation, aggressive fed rate hikes, reducing or tapering of the Fed’s balance sheet, lack of stimulus support from the government, rising inventories, weakening retail sales, declining real disposable incomes, and high gas and food prices weighing on consumption.
Another major concern is decreased earnings, as the Fed hikes rates to slow economic growth, they risk putting the economy into a contraction. With consumers dependent on low rates to support economic growth via debt. Since earnings remain highly correlated with economic growth, earnings don’t survive rate hikes. As the arrows show Fed rate hikes lead to earnings recession.
During the previous four recessions and subsequent bear markets, the typical revision to consensus EPS estimates ranged from -6% to -18%, with a median of -10%. So far, those estimates have not fallen enough. While forward Price/Earnings ratios have declined, much of that is due to the decline in the Price and not the Earnings. Therefore, if an earnings recession is coming, as the data suggests, then the current bear market still has more work to do as earnings decline.
However, there is a positive side to these down markets and a potential recession. They present great times to invest your money while many securities are trading at a discount. Based on history, the evidence overwhelmingly points to great market returns over the next 1, 3, and 5 years, whether we have a recession or not!
June Market Outlook
“Go to cash and get out of the markets as you are going to lose all of your money….”
Negative headlines, for a fact, catch your attention twice as much as positive headlines, especially when it comes to the stock and bond markets. The media’s job is to sell their stories, and negative stories sell much more than positive stories. I have recently returned from 3 national economic/investment conferences, in which we had many experts speak to us on the current economy and investment markets. I would like to offer our clients and friends, balanced facts about the markets:
We, at Traditions Wealth, will continue to educate you on a balanced look at the facts. We also believe we could have a recession as early as next year in 2023, but are you at risk of losing all your invested assets - NO!
As a Fiduciary, always acting in your best interest, we will bring you more true data in the future. Please contact us with any questions at 979-694-9100 or