Nobody Said It Would Be Easy…

Written by Tom Stanley, Investment Adviser, 23 June 2022

A close friend (not far off retirement) asked me the other day:
“Should I suspend my KiwiSaver contributions, and save the money in a bank account, with a view to invest the contributions when markets aren’t looking so dire?”
This question is the inspiration for this month’s note – as a hint to my answer, this note touches on ‘discipline’, ‘fear (and greed)’, and the ‘unpredictable nature of investment returns’.
Before I get too deep, let’s start with a couple quotes from some investment greats:
“It is wise for investors to be fearful when others are greedy and greedy when others are fearful.”
Warren Buffett
“People are always asking me where’s the outlook good, but that’s the wrong question. The right question is: Where is the outlook the most miserable?”
Sir John Templeton, The Principle of Maximum Pessimism
Since I last wrote to you, we have had New Zealand’s economy contract with Q1 GDP at -0.2%, US inflation surprising to the upside, and the Federal Reserve (US central bank) hiking interest rates +0.75% (the largest single rate hike since 1994). As these events played out, local and international markets have continued to sell off, albeit in a somewhat orderly fashion (so far) – To add to this, the Bond Market is experiencing volatility that hasn’t been seen since the onset of the Pandemic or the GFC, but nothing has ‘broken’ – yet.
As you would expect with these events, it has been a particularly tough year to be an investor – But, how tough?
About as tough as it has been for any living investor…
Jim Bianco, of Bianco Research, highlights this point in the chart below of Year-to-Date Returns for the S&P500 (US Stock Market Index) all the way back to 1926:  
“Through June 17th, the S&P 500 is down -22.91%. Only 1932 was worse through to this point. 1962 was close. If the year was to finish here, it would be the 7th worst – No one has seen anything like this year.” (Blue = 2022, Green = Best, Red = Worst)
With all these events playing out, I don’t know if we’re at the point of maximum pessimism yet but there certainly isn’t a lack of it right now.
The S&P 500 fell -11.5% in the past two weeks. The US CPI report Friday week ago was the most often cited culprit, the year over year rate of inflation clocking in at 8.6% with the core (ex-food and energy) at 6%. Those are not good numbers obviously but I’m not sure all that much has changed. The year over year change in core CPI peaked in March and is coming down, albeit slower than we’d all like to see. Market expectations for inflation were also basically unchanged on the CPI news.
While NZ Q1 GDP growth came in negative last week, the global macro picture didn’t change a whole lot either. Globally, the economy is slowing in some areas and inflation is still high but probably peaking. That’s the same as it was the week before, and but after the +0.75% interest rate hike there is a fear, rampant fear, that Reserve Banks are going to hike interest rates too far and put us in recession. While reserve banks do have form of ‘hiking till something breaks’, I don’t think we should underestimate the economy either. What is happening with the economy is not only unsurprising but necessary. Does anyone think that house prices should continue to rise at +20% per year? Is that healthy in any way? I don’t think so, and the only way that was going to change was by slowing the housing market until supply can catch up with demand. 2 year mortgage rates up from 3% to 6% are doing exactly that and while there may be some pain in the short term, this had to happen. With household debt costs coming off record lows, 6% mortgage rates should not be onerous and buyers or sellers, and developers should adjust.

Source: RBNZ Statistics

I am not some blind optimist though. Looking at data in aggregate often obscures as much as it reveals, and yes, there are recession indicators flagging up. Furthermore, rapidly rising interest rates and higher prices at the pump (and checkout) are not good for anyone. But, how much pain is already priced into markets? Recently the preliminary June University of Michigan Consumer Sentiment survey came out. From an investment perspective, this is most often useful as a contrarian indicator that will help you do what Buffet and Templeton say you should – buy when everyone else is gloomy:

Source: Federal Reserve Economic Data (FRED)

I don’t think the above chart requires a lot of explanation but the red line is the Wilshire 5000, a broad measure of the US stock market. The blue line is the University of Michigan consumer sentiment survey. Consumer sentiment is a pretty good contrarian indicator, an indication of when “others are fearful”. Maybe we aren’t at maximum pessimism yet but if the preliminary June figure is confirmed at month end, it will be an all-time low. Could stocks sell off more? Yes, they certainly could, but with sentiment at an all-time low I think you have to at least consider buying some, and if you are currently working, regularly contributing to KiwiSaver or an Investment Account (that isn’t a cash fund) your are. Now. you aren’t going to get the timing perfect; even Warren Buffett says he’s a terrible market timer. But buying stocks with sentiment at an all-time low surely puts the odds in your favour.
Back to my friends question – what is my answer? (If it is not already clear):
Don’t cut your contributions to your retirement accounts just because markets are down and,
If you have cash on hand, it might feel odd, but look at putting it to work over the next 3, 6, 9, 12 months.
Why? Because if you suspend your contributions, or try to buy only when the going is good, you run the risk of succumbing to mis-managed fear and greed, leading to buying high, and selling low….

Also, bear markets can resolve themselves quickly, and while bull markets often last for years, a significant portion of the gains typically accrue during the early months of a recovery. This article from ‘the balance’ does a great job of inspecting previous bear markets and bounce backs:
“After the S&P 500 bottomed at 777 on Oct. 9, 2002, following a 2.5-year bear market, the stock index then gained 15% over the following month and a total of 34% over the following year.”
“The S&P 500 bottomed at 676.5 on March 9, 2009, after declining 57%. From there, it began a remarkable ascent, roughly doubling in the following 48 months.”

The argument against timing the market is also confirmed closer to home. The below chart from the team at Consilium shows that over the past 30 years (in New Zealand markets), the best month of the year, each year, accounts for almost the entire additional return of shares vs term deposits.

To close out, let’s look back to Mr. Buffet – True to his quote, he is making the most of this bear market, with recent regulatory filings showing his company Berkshire Hathaway buying shares again. Now this doesn’t mean the market is undervalued, or will rebound in the near future, but highlights that a professional ‘value’ investor with a great track record still sees opportunity in what has been a sea of red and hopefully provides some peace of mind.  
In the near term, we expect the road to remain bumpy with stock and bond markets at the mercy of inflation, and while recession is a high probability event, avoiding falling into the trap of mis-managed fear and greed is key – Nobody said this investment thing was going to be easy, that’s why we are here to help you along the way –  We’re locals investing for locals.
Note: Please do not take this article as a prompt to “spend all your cash right now and go to all stocks”. When we maintain our discipline, and have a clear strategy, it’s evident “all or nothing” is not the right answer, and is often the attitude that gets investors in trouble.

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