Beware, a Cautious Climb Continues
Article Series: Part II
By Steven Higgins, Financial Advisor, Principal
As we begin the new year, we do so with continued momentum in both the stock and bond market. We are in full recovery mode, largely due to the much improved inflation environment, which contributes to a less hawkish and possibly dovish monetary policy going forward. The synergy of inflation and interest rates heading in a positive direction continues to overpower the onslaught of headline negativity resulting from: political discord, war, and the economic cracks spawning from a tighter monetary policy. In part one of this two part series, Allison Schmidt writes in her article, Behold a Recovery:
“…This was all in the face of bank collapses, devastating war, political infighting resulting in a near government shutdown here at home, and a Fed that continued to hike rates methodically into the summer, where we had a pause at 5.50%, which is where we sit today.”
As of mid-January, the S&P 500 has been venturing into new territory setting several new all-time highs. The last time we marked a new high was over 24 months ago before spending two temperamental years in a bear market as we worked our way through the challenge of 40 year high inflation. Here we are, at last: recovered. So why the persistent negativity? Yes, investments are largely recovered, but nerves are raw and while this storm has passed we emerge with some trepidation as we nervously take stock of the damage and remain leery of what’s next. This is absolutely normal. I always want to remind clients that it never actually feels like clear sailing, you’re either in the storm or expecting the next. History tells us that recovery leads to expansion, albeit with volatility and pitfalls along the way. So, as we gear up for the climb, we do so with a preparedness and caution as we take our first steps to new heights. It’s important to measure our steps and make sure that we do so with solid ground underfoot. In part one of this series, Behold a Recovery, Allie explained how we positioned our investment process to reflect the current economic realities, as well as used tactical opportunities, to use the momentum of the market in both positive and negative environments to better equip our clients to meet their goals.
Pressing forward, there are two key challenges we want to make sure our clients are conscious of and prepared for: Aftershocks and Politics.
- Inflation Aftershocks – Recoveries are not linear and are full of moments that make us second guess. In June of 2022, inflation peaked at 9.1%, a 40 year high. Since then, looking at monthly inflation data from the Bureau of Labor and Statistics, we have seen a marked and consistent decline in inflation. Because of the way inflation data is reported, it can take an entire year for inflation figures to move meaningfully. By annualizing the data, we saw the decline of inflation happening faster than some realized. There will be months that see spikes in inflation data, and this may briefly whipsaw the markets as investors may be tempted to believe the inflation monster still lives. Think about what it took to get to the June 2022 inflation peak – unprecedented massive global government stimulus during the pandemic, long-term near zero interest rate policy making the cost of borrow historically low, and global supply chain disruption as evidenced by cargo ships meandering off the coast of California waiting up to a month to unload their stock. None of these issues persist today and normal fluctuations of monthly inflation data will be expected.
2. Political Angst and Emotional Motivations – Let’s face it, there’s nothing that triggers regretful emotional responses quite like politics and emotional reactions are at the heart of most bad financial decisions. While everyone should exercise their right and patriotically participate in the democratic process of elections, it’s imperative to keep the oft-nasty and negative political rhetoric out of your long-term financial planning strategy as there in no historical data to support an argument that your (or my) candidate’s success in the election will weigh more favorably on economic outcomes. While it’s safe to say that volatility often visits frequently during presidential election years, the year as a whole is notoriously positive for the stock market with the S&P 500, a broad measure of US stocks seeing positive returns 20 out of 24 presidential election years since 1928. The average return for stocks in those years was over 11%. While the historical backdrop illustrated in the chart below is certainly anecdotal and not a practical prediction of what lies ahead for 2024, it certainly helps make the case that election years, historically, have been notably more likely to be positive than non-election years. When we put a bow on 2024, speculation will have turned to reality and predictions will have evolved to outcomes. Hindsight will be perfect, but we strongly encourage our clients not to “bet the outcome” of this election year.
While the nature of planning and risk management is to keep a keen eye on challenges and potential pitfalls, it also makes sense to acknowledge the positive elements of the current landscape as well. After two years of waging war on inflation, we can see the rate of inflation has slowed meaningfully. Not to say that prices are coming down – they aren’t. Whether the result of the combined efforts of global central banks or the moderating of post-pandemic supply disruptions (likely both), we’ve seen inflation drop from a 40 year high 9.1% to the low 3’s, approaching the Fed’s goldilocks target of 2%. While several anti-inflation weapons have been deployed, none have been wielded more fiercely than the Federal Reserve’s most aggressive interest rate hiking campaign in history. With the Fed’s benchmark rate leaping from 0% to over 5% in less than 18 months, there have been some signs of effectiveness beyond the decline in inflation data. In some sectors, namely technology, we’ve seen significant layoffs as easy money has dried up. With economic cracks likely to appear in other areas, such as commercial real estate, we may see the Fed, with their increasing comfort that inflation is less of a threat, begin to decrease the overnight rate. While the unicorn scenario of a “soft landing” has become something of a base case for some, the reality of potential recession cannot be ignored and the more red flags that wave will likely prompt to the Fed to cut rates sooner. For the time being, there is some wind in the sails and the momentum gained from the bear market recovery and establishment of a new bull market persists. While at times the climb feels less like an ascent and more like survival, and while we are cautions of the conditions that lay ahead, we once again march forward to the likely surprise of whatever is next.
Financial planning and investment management are not hard sciences with repeatable or predictable outcomes. The multi-dimensional elements of economics, emotions, time, and – most of all – client’s goals and dreams all contribute to the unknowable potential of varying outcomes. Never is the process of planning complete or concrete. Within our own personal ecosystem, our goals and dreams change over time, and combined with the external changes of the world around us, we need to engage in meaningful discussions as we move forward. There are dynamic elements to the process for sure, but there are some foundational aspects that are more firm. Binary approaches to planning and investing don’t work. The all-in or all-out approach is often the result of emotional wagers on potential outcomes. At Higgins and Schmidt Wealth Strategies, as part of our process, we engage meaningfully with our clients on a regular basis to address the aspects of life that are most meaningful to you. Allie and I take great care to research and understand the economic and market noise that can potentially distract our clients from the process and their own goals. We are by no means economists and we’ve got no crystal ball, but we do take a lot of pride in staying close to the pulse and tenor of what is most important to our people.
Off we go … a cautious climb continues.
Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through Higgins & Schmidt Wealth Strategies, a registered investment advisor and separate entity from LPL Financial.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification and asset allocation does not ensure a profit or protect against a loss. Stock investing involves risk including loss of principal.
Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price. Rebalancing a portfolio may cause investors to incur tax liabilities and/or transaction costs and does not assure a profit or protect against a loss.
