An Irreverent “State of the Investment World” Address
The financial news in the first few weeks of each new year is replete with articles recapping the highlights and lowlights of the investment markets over the previous year along with market predictions the new year. Readers of this blog likely know of my disdain for the media’s persistent pessimism (fear sells) and of my outright rejection of all stock market prognostications. As the title of this missive suggests, my January 2023 “State of the Investment World” address is an irreverent response to such nonsense.
The State of the Stock Market
To begin, despite the litany of insufferable headlines about how terrible 2022 was for investors, I submit that 2022 was cathartic for FPH clients. While some investors bemoan the dramatic declines in the over-hyped unicorn stocks and/or the cryptocurrency markets, those speculative investments were never part of our long-term investment discipline. For the better part of the last five to seven years it has been a challenge to steer our clients away from the ”get-rich-quick” allure of such investments and to overcome FOMO. In my opinion, the 50%+ declines in many of these inherently speculative investments represents a welcome blowing off of the froth of the stock market. As I have commented in other blog posts, in many instances, I believe the declines in some of these investments may be permanent (i.e., resist the temptation to catch a falling knife).
Why is the Stock Market Down?
“But isn’t the overall stock market down significantly from its highs too?” you may ask. The short answer is, YES. In fact, the large cap U.S. stock market, as measured by the S&P 500 index, has been hovering between 10% and 20% off its January 3, 2022 all-time high for several months. One of the most challenging concepts to impart on investors is that such declines are actually a good thing! The volatility in the share prices of the companies that comprise the stock market is what enables stock market returns to exceed the risk-free rate over most long-term time periods. As I explained in a previous post, one of the primary reasons why the U.S. stock market has eventually always gone higher over time is that it is made up of real companies with real profits. As these companies’ earnings grow over time, they are inherently worth more in the same way that your net worth grows over time if you save more than you spend.
Stock Market Ups & Downs
We tell every single new client at FPH, “Sometimes the stock market goes down. Sometimes a little bit. Sometimes a lot. Sometimes the decline is short-lived. Sometimes the decline may last a few years or so. Expect it. It is normal. It is healthy.” Similarly, we also preach that temporary market declines are not the same as permanent losses. As long as you can wait until the stock market recovers and goes higher, you will not lose money. Further, especially for people who are saving for longer term goals, such as college or retirement, down markets should be viewed as opportunities to make up for savings shortfalls. I am always flabbergasted when I conduct 401(k) employee education meetings and participants express their concerns over their account values declining when the stock market drops. If you are saving for retirement, YOU WANT THE STOCK MARKET TO BE DEPRESSED WHEN YOU ARE CONTRIBUTING! I can’t say it any more clearly than that. Consistently contributing through all market environments allows you to buy more shares when the stock market is depressed and fewer when it is at its peak. It is a tried-and-true way to build wealth, but one which individual investors struggle mightily to follow.
Simplified Investing
I have come to realize that the irrational propensity of investors to sell (or stop investing) when the stock market is depressed is largely attributable to a lack of understanding of what they own. Investing should not be an ephemeral concept. It is not Pixie dust. It is not crypto. If you are investing in large-cap U.S. index funds and/or a diversified basket of rising dividend stocks, you are purchasing shares of real companies with real profits. Even if a company’s earnings decline from one year to the next due to a slowing economy, investors should understand that declining earnings are not the same as losing money. Viewing investing in the stock market through this lens should make it much easier to not only ride out down markets but to take advantage of the opportunities they present.
Stock Market Predictions 2023
As for predictions for the stock market in 2023, there is an Everest-sized pile of published empirical research demonstrating that the stock market follows a random walk that defies prediction. I have no idea whether the market will be higher or lower. All I do know is that I am happy to have the opportunity to buy the U.S. stock market at 10-20% off and to invest in dozens of great rising-dividend companies at 10%-40% off today. If they get cheaper this year, so much the better.
The Outlook for Interest Rates and the Bond Market
Many 2022 year-end reviews lament terrible investment returns in 2022 because of simultaneous double-digit declines in the stock and bond markets. This was really only a problem for bond mutual fund holders. This was not a problem for most FPH clients because we advised anyone who would listen over the past few years to eliminate bonds mutual funds in all accounts and to hold the proceeds in cash in anticipation of increasing interest rates.
The bond market is not like the stock market, it does not follow a random walk. We were shouting from the rooftops that interest rates simply could not go lower and that when they eventually rose, it would be disastrous for the values of the existing bond portfolios in bond mutual funds. I am baffled as to why so many money managers whiffed on this. While I have not been shy about patting myself on the back for explaining that this would happen, it was no stroke of brilliance. It should have been obvious to just about everyone. The biggest mystery to me was why it wasn’t.
In avoiding the bond market declines, we have been recommending clients shift cash into short-term CDs and treasury securities since last March and April. While we may have been a little early in making that call, no one who purchased a 1.5% 12-month CD a year ago will lose money and when it matures, the renewal rates now are much higher.
Looking ahead, it is more difficult to foretell where interest rates on bonds will go from here than it was when yields were close to zero. However, I am confident in stating that the historic lows of 2021 in terms of both lending rates and fixed income investment yields were a historical anomaly. In my opinion, it is extremely unlikely that rates will return to those levels any time soon. (I would guess not again in my lifetime.) The current inverted treasury yield curve (the 10-year treasury yield is approximately 3.8% while the 52-week T-bill sits at around 4.9%), suggests that interest rates may decline over the next year or two if inflation subsides considerably and/or if the economy weakens considerably. However, despite the dramatic rise in interest rates over the past 12 months, bond yields are still below their historical average over the past century.
Real Investment Advice
My clear and unambiguous advice is to continue to buy CDs, treasuries, and perhaps even government agency securities and to spread the maturities out as far as three years. If rates decline a bit, you will be happy that you locked in the 2- and 3-year yields, while if rates rise, you will still have maturing bonds to take advantage of the hikes. If rates continue to rise, I recommend gradually extending your bond ladder.
NOTE: I have tempered my enthusiasm for Series I Savings Bonds. While the 6-month yield on i-bonds through April 2023 remains attractive at 6.89%, the Treasury Direct website is so dysfunctional and understaffed that I wonder if investors are going to face pain and disillusionment when they try to redeem their bonds in a lower rate environment.
Cash is the Low-Hanging Fruit in the Search for Higher Portfolio Returns
These days, an easy way for many people to boost portfolio returns may be to shift low/no-yielding cash from bank deposits and brokerage sweep accounts into either government securities money market funds or short-term CDs and treasuries. For years, cash has been a drag on portfolio returns. Not anymore. Today, investors can get safe, liquid cash equivalents with yields ranging from 4-5%.
Summary – Investing is Getting Easier
The central thesis of this essay is that, contrary to the pervasive pessimistic sentiment, 2022 was helpful in eradicating speculative excesses from the stock market and in refocusing investors on sound business fundamentals and earnings. For investors who avoided the carnage caused by owning bond mutual funds, rising interest rates are actually a welcome sight. At long last, interest income from bonds and cash can contribute to portfolio returns again! The ability to generate sufficient passive portfolio income from interest and dividends that one need not ever spend down principal may be considered the Holy Grail of retirement investing, and we are not too far from that today.
These days, I am surprised at how pervasive pessimistic sentiment is in the investment community. 2022 provided ample examples of the perils of succumbing to groupthink, so I am guessing that much of the pessimism is from folks who have sour grapes over losses in crypto, cannabis stocks, plummeting unicorn stocks, and/or bond mutual funds. My advice to those folks is being wrong twice is not going to make you feel better. Speaking on behalf of Financial Planning Hawaii, we have never felt more confident or secure in the guidance we are giving our clients.
John H. Robinson is the owner/founder of Financial Planning Hawaii, Fee-Only Planning Hawaii, and Paraplanning Hawaii. He is also a co-founder of fintech software-maker Nest Egg Guru.
DISCLOSURES
Securities offered through J.W. Cole Financial, Inc. (JWC) member FINRA/SIPC. Advisory services offered through Financial Planning Hawaii and J.W. Cole Advisors, Inc. (JWCA). Financial Planning Hawaii and JWC/JWCA are unaffiliated entities
Fee-only financial planning services are provided through Financial Planning Hawaii, Inc. DBA Fee-Only Planning Hawaii, a separate state of Hawaii Registered Investment Advisory firm. Financial Planning Hawaii does not take custody of client assets nor do its advisers take discretionary authority over client accounts.
The information contained herein is general in nature. Neither Financial Planning Hawaii nor J.W. Cole provides client-specific tax or legal advice. All readers should consult with their tax and/or legal advisors for such guidance in advance of making investment or financial planning decisions with tax or legal implications.
