Discover more from TKer by Sam Ro
Smart people agree that the best investing wisdom shares a common theme 🧐
Plus a charted review of the macro crosscurrents 🔀
Stocks fell last week, with the S&P 500 falling 2.9% to close at 4,320.06. It was the worst week since March. The index is now up 12.5% year to date, up 20.8% from its October 12 closing low of 3,577.03, and down 9.9% from its January 3, 2022 record closing high of 4,796.56.
It’s been a rough couple of weeks in the stock market. After hitting its 2023 closing high of 4,588.96 on July 31, the S&P has been struggling to regain its footing.
But as TKer Stock Market Truth No. 2 reminds us, it’s typical for stocks to experience big drawdowns in any given year. Dealing with market volatility is what investing in risky assets like stocks is all about.
For more, read: Some unnerving stock market charts that may help you stay grounded 🧘🏻
This market slump has had me thinking about a discussion I recently participated in with Bespoke Investment Group’s Paul Hickey and CappThesis’ Frank Cappelleri on the Facts vs. Feelings podcast, hosted by Carson Group’s Ryan Detrick and Sonu Varghese.
As we were wrapping up, Ryan asked us for a timeless piece of investing advice. All of our answers hit on a similar theme. Here’s a lightly edited transcript from the podcast:
Frank: Know your timeframe. And don’t change. You can either be a trader, a short-term trader. Or if you’re long-term, I think you have to be market agnostic.
Paul: Your holding period. A one-day holding period, it’s a coin flip. The longer you’re willing to stick to it, the better. We call it the Montana rule. … Markets have never been down over a 16 year stretch or longer. Time heals in the markets.
Me: Time in the market beats timing the market.
Regardless of if you’re trading for the short term or investing for the long term, making money in the stock market is a process. And processes involve time.
So, whether you’re a chart guru like Frank or you’re a data god like Paul, the key variable when considering a trade or an investment is time.
‘Time heals in the markets’ 🕰️
In some cases, it might be appropriate to operate on tight timeframes. In many other cases, the move is to have a long timeframe.
The chart below backs up Paul’s observation. From Bespoke Investment Group: “Historically, the odds of the S&P 500 being up over any one-month timeframe have been 62.6%. Over a year, the odds of being up jump to 74.6%, and over eight years, they jump to 97%. Since 1928, all 16+ year time frames have seen positive returns.“
And by the way, this only works if you stay put in the market. The more you weave in and out of the market, the more you risk missing out on those important stretches of gains that can make or break your long-term performance. As the saying goes, “Time in the market beats timing the market.”
Related from TKer:
Reviewing the macro crosscurrents 🔀
There were a few notable data points and macroeconomic developments from last week to consider:
🏛️ The Fed keeps rates unchanged. On Wednesday, the Federal Reserve kept monetary policy tight, leaving its target for the federal funds rate unchanged at a range of 5.25% to 5.5%.
From the Fed’s policy statement: “Recent indicators suggest that economic activity has been expanding at a solid pace. Job gains have slowed in recent months but remain strong, and the unemployment rate has remained low. Inflation remains elevated.“
In a press conference, Fed Chair Jerome Powell acknowledged that inflation has been pretty moderate recently. But he said it would take more than a few months of data to convince the central bank that inflation was indeed under control.
“We want to see that these good inflation readings that we've been seeing for the last three months, we want to see that it's more than just three months,” Powell said.
The Fed also raised its estimates for GDP growth in 2023, and 2024; lowered its estimates for the unemployment rate in 2023, 2024, and 2025; and lowered its estimate for core PCE inflation in 2023. It also raised its projection for the fed funds rate in 2024 to 5.1% from 4.6%. Taken together, these revisions were considered hawkish.
For more on monetary policy, read: A big misconception about the Fed's fight to bring down inflation 🙃
📈 Interest rates are up. The yield on the 10-year Treasury note hit 4.5% for the first time since 2007.
While rising interest rates represent a headwind for consumers and businesses, keep in mind that consumer and business finances are unusually strong.
💵 Household finances are in good shape. From WSJ’s Nick Timiraos: “Debt service payments as a share of household income edged ever so slightly *lower* in Q2 from the previous quarter and from the year-earlier quarter.“
For more on household finances, read: People have money 💵
💼 Unemployment claims fall. Initial claims for unemployment benefits declined to 201,000 during the week ending September 16, down from 220,000 the week prior. It was the lowest print since January. While this is up from a September 2022 low of 182,000, it continues to trend at levels associated with economic growth.
For more on the labor market, read: The hot but cooling labor market in 16 charts 📊🔥🧊
💼 Job openings stabilize. From Indeed’s Nick Bunker: “Online job postings aren't falling like they were earlier this year. In fact, they aren't falling at all. The Indeed Job Postings Index has moved sideways over the past 3 months.“
For more on job openings, read: How job openings explain everything in the economy 📋
🏚 Home sales cool. Sales of previously owned homes fell 0.7% in August to an annualized rate of 4.04 million units. From NAR chief economist Lawrence Yun: “Mortgage rate changes will have a big impact over the short run, while job gains will have a steady, positive impact over the long run. The South had a lighter decline in sales from a year ago due to greater regional job growth since coming out of the pandemic lockdown.“
For more, read: The U.S. housing market has gone cold 🥶
💸 Home prices ticked up. Prices for previously owned homes rose month over month and were up from year-ago levels. From the NAR: “The median existing-home sales price climbed 3.9% from one year ago to $407,100 – the third consecutive month the median sales price surpassed $400,000.“
For more on home prices, read: Why home prices and rents are creating all sorts of confusion about inflation 😖
🏠 Homebuilder sentiment falls. From the NAHB’s Alicia Huey: “The two-month decline in builder sentiment coincides with when mortgage rates jumped above 7% and significantly eroded buyer purchasing power. … And on the supply-side front, builders continue to grapple with shortages of construction workers, buildable lots and distribution transformers, which is further adding to housing affordability woes. Insurance cost and availability is also a growing concern for the housing sector.“
🔨 New home construction drops. Housing starts fell 11.3% in August to an annualized rate of 1.28 million units, according to the Census Bureau. Building permits rose 6.9% to an annualized rate of 1.54 million units.
For more, read: The U.S. housing market has gone cold 🥶
⛽️ Gas prices are up from a year ago. From AAA: “The national average for a gallon of gas hit what may be 2023’s peak price of $3.88 earlier this week, only to slide a few cents in the following days. Today’s average is $3.86 – a penny more than a week ago.“
For more on energy prices, read: The other side of the surging oil price story 🛢
💳 Spending is holding up, according to September card data. From JPMorgan Chase: “• As of 17 Sep 2023, our Chase Consumer Card spending data (unadjusted) was 0.5% above the same day last year. Based on the Chase Consumer Card data through 17 Sep 2023, our estimate of the US Census September control measure of retail sales m/m is 0.23%.“
For more on spending, read: Don't underestimate the American consumer 🛍️
🍾 The entrepreneurial spirit is alive. Small business applications, while down slightly from the previous month, remain well above prepandemic levels. From the Census Bureau: “August 2023 Business Applications were 466,163, down 0.9% (seasonally adjusted) from July. Of those, 149,785 were High-Propensity Business Applications.“
👎 Survey says growth is cooling. From S&P Global’s September Flash U.S. PMI: “PMI data for September added to concerns regarding the trajectory of demand conditions in the US economy following interest rate hikes and elevated inflation. Although the overall Output Index remained above the 50.0 mark, it was only fractionally so, with a broad stagnation in total activity signalled for the second month running.“
But… : “Despite a muted sales environment, US businesses registered greater hiring activity during September. The rate of job creation quickened to the fastest since May and was solid overall. In fact, the pace of employment growth was among the most elevated seen in the past year amid some reports that staff retention was improving. Companies also noted that vacancies were filled with greater ease than had been seen in recent months.“
Keep in mind that soft survey data isn’t quite as reliable as hard data.
For more on this, read: What businesses do > what businesses say 🙊
🇺🇸 Most U.S. states are still growing. From the Philly Fed’s State Coincident Indexes report: “Over the past three months, the indexes increased in 40 states, decreased in eight states, and remained stable in two, for a three-month diffusion index of 64. Additionally, in the past month, the indexes increased in 30 states, decreased in 13 states, and remained stable in seven, for a one-month diffusion index of 34.”
📈 Near-term GDP growth estimates remain positive. The Atlanta Fed’s GDPNow model sees real GDP growth climbing at a 4.9% rate in Q3.
For more on the forces bolstering economic growth, read: 9 reasons to be optimistic about the economy and markets 💪
Putting it all together 🤔
This comes as the Federal Reserve continues to employ very tight monetary policy in its ongoing effort to bring inflation down. While it’s true that the Fed has taken a less hawkish tone in 2023 than in 2022, and most economists agree that the final interest rate hike of the cycle has either already happened or is near, inflation still has to cool more before the central bank is comfortable with price stability.
So we should expect the central bank to keep monetary policy tight, which means we should be prepared for tight financial conditions (e.g., higher interest rates, tighter lending standards, and lower stock valuations) to linger. All this means monetary policy will be unfriendly to markets for the time being, and the risk the economy slips into a recession will be relatively elevated.
At the same time, we also know that stocks are discounting mechanisms, meaning that prices will have bottomed before the Fed signals a major dovish turn in monetary policy.
Also, it’s important to remember that while recession risks may be elevated, consumers are coming from a very strong financial position. Unemployed people are getting jobs, and those with jobs are getting raises.
Similarly, business finances are healthy as many corporations locked in low interest rates on their debt in recent years. Even as the threat of higher debt servicing costs looms, elevated profit margins give corporations room to absorb higher costs.
At this point, any downturn is unlikely to turn into economic calamity, given that the financial health of consumers and businesses remains very strong.
And as always, long-term investors should remember that recessions and bear markets are just part of the deal when you enter the stock market with the aim of generating long-term returns. While markets have had a pretty rough couple of years, the long-run outlook for stocks remains positive.
For more on how the macro story is evolving, check out the the previous TKer macro crosscurrents »
TKer’s best insights about the stock market 📈
Here’s a roundup of some of TKer’s most talked-about paid and free newsletters about the stock market. All of the headlines are hyperlinked to the archived pieces.
The stock market can be an intimidating place: It’s real money on the line, there’s an overwhelming amount of information, and people have lost fortunes in it very quickly. But it’s also a place where thoughtful investors have long accumulated a lot of wealth. The primary difference between those two outlooks is related to misconceptions about the stock market that can lead people to make poor investment decisions.
Passive investing is a concept usually associated with buying and holding a fund that tracks an index. And no passive investment strategy has attracted as much attention as buying an S&P 500 index fund. However, the S&P 500 — an index of 500 of the largest U.S. companies — is anything but a static set of 500 stocks.
For investors, anything you can ever learn about a company matters only if it also tells you something about earnings. That’s because long-term moves in a stock can ultimately be explained by the underlying company’s earnings, expectations for earnings, and uncertainty about those expectations for earnings. Over time, the relationship between stock prices and earnings have a very tight statistical relationship.
Investors should always be mentally prepared for some big sell-offs in the stock market. It’s part of the deal when you invest in an asset class that is sensitive to the constant flow of good and bad news. Since 1950, the S&P 500 has seen an average annual max drawdown (i.e., the biggest intra-year sell-off) of 14%.
There’ve been lots of talk about the “yield curve inversion,” with media outlets playing up that this bond market phenomenon may be signaling a recession. Admittedly, yield curve inversions have a pretty good track record of being followed by recessions, and recessions usually come with significant market sell-offs. But experts also caution against concluding that inverted yield curves are bulletproof leading indicators.
Every recession in history was different. And the range of stock performance around them varied greatly. There are two things worth noting. First, recessions have always been accompanied by a significant drawdown in stock prices. Second, the stock market bottomed and inflected upward long before recessions ended.
Since 1928, the S&P 500 generated a positive total return more than 89% of the time over all five-year periods. Those are pretty good odds. When you extend the timeframe to 20 years, you’ll see that there’s never been a period where the S&P 500 didn’t generate a positive return.
At some point in the future, we’ll learn a new bull market in stocks has begun. Before we can get there, the Federal Reserve will likely have to take its foot off the neck of financial markets. If history is a guide, then the market should bottom weeks or months before we get that signal from the Fed.
While a strong dollar may be great news for Americans vacationing abroad and U.S. businesses importing goods from overseas, it’s a headwind for multinational U.S.-based corporations doing business in non-U.S. markets.
The stock market sorta reflects the economy. But also, not really. The S&P 500 is more about the manufacture and sale of goods. U.S. GDP is more about providing services.
…you don't want to buy them when earnings are great, because what are they doing when their earnings are great? They go out and expand capacity. Three or four years later, there's overcapacity and they're losing money. What about when they're losing money? Well, then they’ve stopped building capacity. So three or four years later, capacity will have shrunk and their profit margins will be way up. So, you always have to sort of imagine the world the way it's going to be in 18 to 24 months as opposed to now. If you buy it now, you're buying into every single fad every single moment. Whereas if you envision the future, you're trying to imagine how that might be reflected differently in security prices.
Some event will come out of left field, and the market will go down, or the market will go up. Volatility will occur. Markets will continue to have these ups and downs. … Basic corporate profits have grown about 8% a year historically. So, corporate profits double about every nine years. The stock market ought to double about every nine years… The next 500 points, the next 600 points — I don’t know which way they’ll go… They’ll double again in eight or nine years after that. Because profits go up 8% a year, and stocks will follow. That's all there is to it.
Long ago, Sir Isaac Newton gave us three laws of motion, which were the work of genius. But Sir Isaac’s talents didn’t extend to investing: He lost a bundle in the South Sea Bubble, explaining later, “I can calculate the movement of the stars, but not the madness of men.” If he had not been traumatized by this loss, Sir Isaac might well have gone on to discover the Fourth Law of Motion: For investors as a whole, returns decrease as motion increases.
According to S&P Dow Jones Indices (SPDJI), 59.7% of U.S. large-cap equity fund managers underperformed the S&P 500 during the first half of 2023. As you stretch the time horizon, the numbers get more dismal. Over a three-year period, 79.8% underperformed. Over a 10-year period, 85.6% underperformed. And over a 20-year period, 93.6% underperformed.
S&P Dow Jones Indices found that funds beat their benchmark in a given year are rarely able to continue outperforming in subsequent years. For example, 318 large-cap equity funds were in the top half of performance in 2020. Of those funds, 39% came in the top half again in 2021, and just 5% were able to extend that streak through 2022. If you set the bar even higher and consider those in the top quartile of performance, just 7% of 156 large-cap funds remained in the top quartile in 2021. No large-cap funds were able to stay in the top quartile for the three consecutive years ending in 2022.
Picking stocks in an attempt to beat market averages is an incredibly challenging and sometimes money-losing effort. In fact, most professional stock pickers aren’t able to do this on a consistent basis. One of the reasons for this is that most stocks don’t deliver above-average returns. According to S&P Dow Jones Indices, only 24% of the stocks in the S&P 500 outperformed the average stock’s return from 2000 to 2022. Over this period, the average return on an S&P 500 stock was 390%, while the median stock rose by just 93%.