Quarterly Commentary – October 2021
Rising interest rates, looming inflation, stock market volatility and a looming debt crisis. What is an Investor to do? I emphasize the word Investor as opposed to Trader. A Trader will be very active in this time of market volatility, but in our opinion, an Investor does very little but in effect watch the circus play itself out. Do I sound a bit cynical? Surely, but consider the following.
First, a quick discussion of the debt ceiling and how it works. Essentially Congress puts a limit on the borrowing power of the Treasury (i.e., printing of money) and when Congress itself passes spending legislation in excess of that year’s federal revenue the need for more debt is created and inevitably with more spending the “limit” on debt is reached and Congress then needs to pass legislation to increase the debt limit so it, Congress, can spend more money. Look at is this way. You have reached the credit limit on your credit card. In order to use the card any further you need to pay down your credit card debt or convince the card issuer to increase your credit limit. But what if you just open another credit card, take a cash advance, and paydown the first card? Problem solved but now you have more debt. That is exactly what our Congress does. Year in and year out, either Party in power, spending just seems to go up. Not passing judgement on the “why” for the spending but just explaining the process of increasing debt limits.
For many years, and through many Administrations, votes to increase the debt ceiling were routine and received very little attention. That all changed in the early 1989 and 1990’s when increasing the debt ceiling began to be used as a tool by the minority political party to exert its power and gain some benefit or the proverbial “pound of flesh” in return for supporting a debt ceiling increase. As with any intense negotiations, going right up to the deadline forces each party to make concessions they may not have made early in negotiations. Both Political Parties use this tactic and to me that is an inappropriate use of the bargaining process. Just my opinion but one I wish more members of Congress would take to heart.
So, what is the bottom line on the debt ceiling debate? Watching the drama play out in Washington DC is certainly unpleasant but nonetheless that is the hand we are dealt and after bringing us to the doorstep of “bankruptcy” once again members of Congress will find some middle ground that enough can support and the federal debt ceiling will be increased and bring “joy” to the financial markets.
Now, in regard to stock market volatility, are the current gyrations a sign of impending doom or the natural flow of popular stock market indexes? Since 1990, the stock market (as measured by the Standard & Poor’s 500 Index) has fallen 14 times by more than 10%, with 3 of those instances over 30%. In each instance, the financial markets righted the ship and stock markets rebounded to new highs. What has been unusual is the dramatic 12 month rise in stock prices but recall the dramatic COVID-19 induced stock market collapse of February/March 2020, so the ensuing rise was from a very low point. The following is from our April 2018 newsletter:
Volatility is back in the financial markets and we believe that is a good thing. Stock markets are driven by buyers and sellers. If all agree, the markets will move in the same direction. Up if all agree to buy and down if all agree to sell. It really is that simple. However, that is not reality. Rarely do we all agree on any particular subject and certainly not on finances. This is why the year 2017 was so unusual. When looking at the major stock market indexes, Standard & Poor’s 500, Dow Jones Industrial Average and NASDAQ there was only 1 month in 2017 when these indexes fell. Dow Jones Industrial and S&P 500 were down in the month of March 2017 and the only negative month for the NASDAQ was June. How unusual was that? Listed below is the number of down months in each of the past ten years for the major indexes.
From this table, you can see how unusual the stock markets were last year. So far in 2018, the “normal” volatility has returned with 2 of the first 3 months being negative. Does this portend future gloom and doom for the financial markets? Possibly, but if you look at the above numbers the probability of that is low. What is much more likely and in line with our current fractured political system is a much greater degree of volatility than we saw last year but overall, the probability of better market conditions as the impact of lower corporate taxes and continued job growth has its full impact on our economy. Quarter to quarter we will definitely see variation but the theme of continued global growth in our opinion will remain on track.
What the above discussion tells us is that stock market volatility is normal, and the abnormal is lack of volatility.
What about inflation? How is that going to impact stock prices. Of course, we have an historic look at that also. In April of 1980 inflation in the US peaked at 14.76%. Imagine that, we are currently concerned about inflation climbing to 5-6%. Ten-Year US Treasury Bonds, on August 31, 1981, were yielding 15.51%. Compare that to the current yield on the 10 Year US Treasury Bond at 1.524%. Financial markets are all a twitter because they fear the 10 Year US Treasury Bond will rise to 2-2.5%. Really? “Free” money has to end at some point and that time may very well be now. Will that crater the stock market? In our opinion, No. Yes, there will be gnashing of teeth and a possible stock market drop (probable in some circles), but again, are you an Investor or a Trader? Investor’s look to weather the current storm, ride it out and wait for sunny days to come.
That theory has worked for the past 100 years or so of stock market movement and we believe will continue for the Investor.
In conclusion, this sounds like a broken record of advice but the Investor, who sticks with their diverse stock allocation, tend to be rewarded over time for their patience.
As always, if you have any questions, please feel welcome to reach out.
Past performance does not indicate future results. This material represents an assessment of the market and economic environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. Forward-looking statements are subject to certain risks and uncertainties. Actual results, performance, or achievements may differ materially from those expressed or implied. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed by LPL Financial. as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. The Standard & Poor’s 500 Index is an unmanaged Index of approximately 500 large US companies. An index is unmanaged and cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment. The Dow Jones Industrial Average (DOW) is a popular indicator of the stock market based on the average closing prices of 30 active US stocks representative of the overall economy. The Nasdaq Stock Market (NASDAQ) is an American stock exchange. It is the second-largest exchange in the world by market capitalization, behind only the New York Stock Exchange located in the same city. Investing involves risk. Loss, including loss of principal may occur. No strategy assures success or protects against loss.