Engines of Prosperity - Patience & Ingenuity
When one is depressed, perspective withers and whines. Negative events congeal in the mind to seem personal, pervasive, and permanent. Nowadays, the $100-cost to fill a gas tank may provoke thoughts of strangling Putin and his OPEC chums.
True, you have to squint to find good news as we face assaults upon wallet and conscience: inflation at a 40-year high; threat of recession; Russia’s carnage in Ukraine; disrupted energy markets further rattled by OPEC’s reduced output; and lingering effects of a pandemic that has forever changed us.
The confluence of current events has shoved the stock market into official bear territory -- down more than 20% from its previous high. An agitated investor may take events as personal when reading his or her latest account statement. It also may feel pervasive, at least for the time being, because no sector (except oil) or region has escaped the downdraft. Putin’s evil and covid’s ripple effects continue to roil the global economy.
But are these conditions permanent? Despite present difficulties, we all know our history: markets do recover though they remain famously fickle as to when. Still, we suggest, no reason to be depressed. Bull markets historically have lasted three times longer than bear markets.
The FUD Factor
In most market scenarios, there are varying degrees of fear, uncertainty, and doubt – “FUD” for short. After the stress of a prolonged downturn, the FUD factor may have an outsized impact when investors become “despondent” or “capitulate” - market-speak for throwing in the towel.
Then there are speculative bubbles like the dot-com bust that followed years of “irrational exuberance.” Once bubbles burst, short-term traders then ask themselves, where was FUD when they needed it?
FUD goes by different aliases stolen directly from the headlines. In 1962, older Boomers remember the Cuban Missile Crisis; in the early Eighties, spiraling inflation; in 2008, the Financial Crisis that brought us to the brink; and so forth. (For a quick trot through nine decades of economic and political history, we attached this link to "92 Years of Bulls and Bears".)
Warren Buffet’s mentor, Benjamin Graham wrote, “Always buy your straw hats in the winter.” This adage hints at a trade secret among investment advisors: encourage caution in optimistic times and grounded optimism in pessimistic times.
So, in that spirit, we include the following chart that goes back 60 years. During that time, the S&P Index ascended from the lowest point of nine bear markets to register some amazing results. On average, the annual returns were 44.14% one year after the low; 16.58% three years after; 14.14% five years after, and 9.71% ten years after.
Bottom line, though future results will vary, the data supports patience, calm, and a consistently applied investment strategy:
Fancy Dance of Inflation Fighting
Declining real estate prices are one result of the Federal Reserve’s aggressive rate hikes. At this point, the Fed is less concerned with possible joblessness as it is laser-focused on tamping down inflation before it becomes endemic, i.e., “spiraling.” Maybe the Fed can pull this off without tipping the economy into recession. The fancy dance continues.
Good news about labor markets: the employment rate is at pre-pandemic levels. Bad news about labor markets (and the economy): continues to run very hot. Covid relief and near-zero interest rates prevented a meltdown during the pandemic. However, the money supply grew far faster than available goods and services, the Miracle Grow for inflation. Many Keynesians, like left-leaning Nobel economist Paul Krugman, now concede that an uptick in unemployment may be an unavoidable piece of inflation reduction.
On the other end of the political spectrum, supply-side economists argue both Congress and the Fed have pumped far too much money into the economy – about three times as much as can be absorbed without creating inflation. There’s a predictable two-year lag before excess money supply increases inflation, so says supply-side economist Steve Hanke of Johns Hopkins University. (No relation but even more opinionated, perhaps as opinionated, Professor Hanke was a recent guest on the podcast, The Problem with Jon Stewart.)
The inflation battle presents a pick-your-poison dilemma as policymakers seek the greatest good for the greatest number and collateral damage upon the fewest possible. Viewing inflation as “the cruelest tax of all,” many investors are willing to endure a short-term recession to correct macroeconomic imbalances. Yet it is the working class that is subject to pink slips and, with pensioners, share acute vulnerability to inflation.
We are days away from the midterm elections, which should have little to no predictable impact upon long-term investors. Research by the Capital Group drew the following conclusions with an examination of midterms and markets since 1934:
- The president’s party typically loses seats in Congress
- Market returns tend to be muted until later in midterm years
- Midterm election years have had higher volatility
- Market returns after midterm elections have been strong
- Stocks have done well regardless of the makeup of Washington
If an obstreperous GOP takes control of the House of Representatives, there will be battles over raising the debt ceiling, promises Minority Leader Kevin McCarthy (R-Calif). Earlier debt-ceiling brinksmanship resulted in major drops in the stock market, government shutdowns, and downgrading of the United States’ credit rating. Recently, the national debt hit the $31 trillion mark.
Elections, the heart of our democracy, do matter as they express our values and aspirations. However, elections do not translate to any workable investment strategy. Long-term returns come from the value of individual companies over time.
The Role of Ingenuity
Regardless of where we are in election or investment cycles, human ingenuity is always at work. Among its inestimable manifestations, ingenuity drives investment returns.
“Sticks and stones led to hammers and spears, the wheel and axle, the steam engine, and eventually semiconductors and jet aircraft,” says Weston Wellington of Dimensional Fund Advisors, writing in the Market Review for Third Quarter 2022.
One innovation often paves the way for others, such as cell phones that combine computer and telephone. Fanfare for yesterday’s innovations, such as microwaves, antibiotics, and transatlantic flight, may recede, but earlier progress is prologue for what more is to come.
“Civilization is a history of innovation – curious minds seeking to improve upon existing ways of meeting humankind’s wants and needs,” observes Wellington. “Public securities markets are just one example of such creativity, and they have a history of rewarding investors for the capital they supply to fund such innovation.”
Speaking of ingenuity, the first practical electric cars appeared in the 1890s. What further innovations will ultimately replace the gas-powered car? We remain curious.
As always, we are available to discuss your investment and financial planning questions.