In a recent interview, Jeremy Siegal, Ph.D., Professor of Finance at Wharton School of Business, said he thinks the market will continue on its historic uptrend during 2022 but at a slower pace than in recent years. Professor Siegel has been a market watcher since the 1970s. Many would call him a permabull, meaning his market outlook is always optimistic.
Other market analysts have different opinions. In fact, the forecasts range from a continuation of the historic uptrend on the bullish side to a cataclysmic market crash like the one in 2000 or maybe worse on the bearish side.
One of the bears, Greg Diamond, a Certified Market Technician, foresees a massive drop in markets that will wipe out pension funds and individual retirement accounts. Market technicians like Greg, look for patterns in stock price movements to make predictions. For example, if a stock peaks but then retreats only to peak a second time, if the second peak is lower than the first, technicians see that as a bad sign. Greg thinks the market will crash on February 11. It’s usually not a good idea for analysts to make such specific predictions. It’s like those prophets who forecast the end of the world in a particular year or, worse yet, on a specific day. Better for predictions to be a little vague, especially when they involve a market crash or the end of the world.
Greg’s prediction is based on market performance to date. Thus far, 2022 has not been kind to investors, especially tech investors. The NASDAQ is down 8% YTD (as of January 18). High-flying stocks like Tesla, NVIDIA, Google and the other FAANGs are doing especially poor. Even the stylish alternative energy and electric vehicle funds have fallen. All investors are wondering what’s causing the bearishness.
One of the contributing factors is inflation. Last week the front page of the WSJ featured a story on inflation. In December the CPI increased at an annualized rate of over 7%. Some CPI categories were up over double digits: household energy (11.6%), new vehicles (11.8%), meats, poultry, fish and eggs (12.5%). Those numbers are enough to make anxiety-prone retirees hide under their beds, but unfortunately the group affected the most is lower income people. Poor people need to buy eggs, gas for their cars and fuel to heat their homes. These kinds of price increases have got to hurt.
The Federal Reserve under the leadership of Jerome Powell has the mandate to control inflation or more accurately to find a sweet spot between inflation and unemployment. Generally during times of high inflation, unemployment is at its lowest because the economy is growing rapidly. And, conversely, when inflation is low, unemployment tends to be high. A goldilocks solution is to keep inflation below 2% and unemployment below 5%. During the 1970s stagflation period, inflation and unemployment were both very high. That period gets the booby prize for the worst managed economy during the later half of the 20th century, at least in the U.S.
During his last update, Chairman Powell said that the Fed would take measures to reduce inflation. The Fed will reduce its purchases of bonds and, at the same time, goose the Fed Funds rate to cause interest rates to increase. For the past few years, actually since 2008, the Fed’s accomodative policies have boosted the stock market. With interest rates at near zero, bonds were not competing for investors’ money, borrowing was cheap and the Fed’s money creation policies fueled the economy and security markets.
Shortly after Powell’s remarks, Mr. Market, the name sometimes given to the collective market, threw a hissy fit, dropping by triple digits day after day. To rub salt in Mr. Market’s wounds, Powell noted that the current inflation is probably not transitory as some analysts had hoped. The current labor shortage will cause wages to continue to increase and the massive federal spending related to COVID, infrastructure and social programs is gasoline on the fire.
What’s an investor to do with fixed income investments yielding close to zero and the stock market at an historic high and showing signs of weakness? Most financial advisors will tell their clients to sit tight, make sure their portfolios are diversified and ride out the storm. Those that are more action oriented will recommend trimming holdings perhaps by selling more volatile stocks in the portfolio. In fact, many investors are already doing that. There’s been a shift from NASDAQ stocks to stodgier dividend stocks. Analysts call this a market rotation.
Historically does sitting tight during bear markets work? Usually it does. During the most recent 20% drops in the market doing nothing was not a bad strategy. Of course, if you could have timed and sold at the peak and bought at the bottom, you would have done much better, but no one can really identify peaks and troughs with much accuracy. The exception to the ‘do nothing’ strategy was the drop in year 2000. During that crash, depending on your portfolio at the time, doing nothing would have been very painful. You would have watched tech stocks lose at least half of their value and then waited for 10-15 years to recover your losses. Ouch!
Financial advisors almost all say ‘do nothing’ at least partly because it’s not risky advice. If they all give the same advice then no one can be blamed for giving exceptionally bad advice. In 1996, during the historic Internet boom market, Elaine Garvarelli, a stock analyst who used an econometric model to predict changes in the market, issued an urgent “sell everything” alert to subscribers in her newsletter. Well, the market did not crash as her model predicted, but just kept rising. That was undoubtedly a career-limiting-prediction for Elaine. Her readers would have been much better off doing nothing than following her advice.
When the market is becoming very volatile, if there’s one group that may not be well served by doing nothing, it’s retirees. That’s because senior citizens have less time to wait for a recovery. Although, as we mentioned, markets usually recover within a few years, another crash like the one in 2000 could cause investors to lose half of their portfolios or more and take a decade or more to recover.
In past years, financial advisors recommended that retirees draw down no more than 4% of their portfolios per year to maintain their standard of living. In that case, assuming the portfolio is earning an average return, a retirement nest egg should last for at least 30 years. But, assume that the market drops by 50% immediately after a person retires and doesn’t recover for 10 years. In that case, the retiree may need to withdraw 8% of their portfolio for a few years and with drawdowns of that magnitude, their nest eggs would not last for 30 years or 25 or even 15. Granted, wealthier retirees don’t need to draw down their portfolios by 4% (or 8%) per year, but statistics show a high percentage of retirees are not well prepared for retirement. Those with less retirement savings would obviously be hurt the most by a market crash.
A big drop in the stock market would also affect pension funds, many of which are invested in stocks. The historic bull market bailed out many private and public pension funds that had been previously significantly underfunded. In that worst case scenario, a 50% decline would be a disaster for some pension funds, state and local governments, corporations offering defined benefit pensions and retirees.
What about the longer term, say the next 10 years? Is Jeremy Siegel right, will the market continue to chug along? Well, some indicators suggest Prof. Siegel may be right. For example, interest rates will probably continue to be low because the U.S. cannot afford to let rates rise by much. So, fixed income investments will continue to pose little competition for equity investments. That’s good for stocks. Also, new technologies like electric vehicles, artificial intelligence, virtual reality, alternative energy, and medical breakthroughs will provide fuel for a rising market.
On the other hand, markets tend to run in cycles and after a long bull run, historically markets tend to adjust or over adjust. Also, inflation is disruptive to many companies. Even if a company is able to increase prices along with the CPI, the timing of wage and price increases is difficult to manage and that affects earnings. Also, inflation affects discretionary spending especially for lower income households and that affects demand for many products.
Bottom line: obviously nobody knows what the next 10 years will hold, but if forced at gunpoint to make a bet, I would put some chips on a slower if not a lower stock market.
So, if I were a financial advisor, what advice would I give to my clients? Well, I’m not a financial advisor, but merely a humble blogger, but if I were, hmmm….I’d probably tell them to do nothing. 🙂
The Ordinary Blog 