Charts of the Month - October

The Most Dangerous Time

“I’m more worried about the world broadly than I’ve ever been in my whole career… I’d be worried we’ll have another 10 years of zero returns.” – Seth Klarman

Seth Klarman may not be a household name or hold the notoriety of other famous investors, but his track record stands tall versus anyone. When he speaks, investors usually listen.

Obviously, that statement is scary—and at face value—investing with caution would seem warranted.

There’s only one problem: that quote is from May 2010. From May 2010 through the end of the decade, the S&P 500 tripled in value.

At present, there is no shortage of items to worry about. Jamie Dimon kicked off JPMorgan’s recent quarterly earnings call by mentioning, “now may be the most dangerous time the world has seen in decades.”

Dimon is primarily alluding to the fact we now have wars raging on multiple continents. And while the world finds itself in a sad state of affairs—that doesn’t foreshadow a doomsday market scenario.

The simple truth is that markets often react negatively to major events over the short-term, but then move past them pretty quickly.

Sampling 20 major global events over the past 80 years, the data shows that markets often react negatively—down 3% on average over 1-month—but then turn positive shortly after, with the median return 1-year after a major event being positive, up more than 6%.

The takeaway? We should not let major global events illicit a reaction to stop investing or get out of the market.

With that being said, the market is currently in its largest drawdown of the year, though the slide began in July, well before recent events.

Correction Territory

The market officially dipped into correction territory—down 10% from a recent high—for the first time this year in late October.

It’s easy to play Monday morning quarterback—of course the market was going to correct!—after it happens.  

You can point to a litany of reasons: war, rising rates, the Fed, political uncertainty. This list could probably be extended to fill every slot on a roulette wheel if you were inclined.

But the easiest thing that can be said in times like these is: this is normal.

In fact, since 1990, the S&P 500 has been down 10% or more from an all-time high approximately 32% of the time.

And yet, the S&P 500 gained more than 2,500% during the period above.

If there was no pain, there would never be any gain.

History shows investors are generally at their worst when they allow the roulette wheel of worries to influence wholesale investment changes.

And we should keep in mind that rebounds often occur suddenly and unexpectedly. Trying to time these reversals—or moving to cash to wait for the market to settle down—often backfires since it means missing out on the earliest (and sometimes most rapid) part of a recovery.

Investors Love Cash

One asset class that has seen massive inflows this year? Cash.

One benefit of rate hikes has been investors can earn a real return on their cash; something that has not been true for a long time. Many money market funds now yield more than 5%, reflecting the path of the Fed’s rate hikes.

Nearly $950 billion has flowed into money market funds this year through October. 

Flows will likely surpass a trillion dollars by year end—eclipsing the high watermark for any year since 2009—and likely the highest ever.

Aswath Damodaran—NYU finance professor widely regarded for his market views—pointed out the shift in investor mindset related to cash on a recent episode of Invest Like The Best, mentioning:

“There’s been a very specific change. If you asked me three years ago how much cash I had in my brokerage account, I didn’t know and I didn’t care. After all, what was I going to do with it? If I put it in T-bills, I made nothing. Today, I’m acutely aware of cash when it’s sitting around. Idle cash means losing cash because of 3-4% inflation—it’s losing value.”

In theory, investors are being paid to wait. They can earn 5% in cash and judging by how they’re voting with their dollars—they love it.

The money market fund industry has nearly $6 trillion in assets now.

It’s hard to differentiate how much of the flows into money markets are coming from checking accounts—where it was earning nothing—and how much was previously invested in stocks, but left searching for yield with less volatility.

It’s probably fair to say it’s some combination of both. But one truth about investing: the comfortable asset is rarely the most rewarding asset.  

Clearly, it feels comfortable to earn 5% in cash while carrying a fraction of the equity risk. But there are other items to consider.

The long-term track record of cash versus stocks shows a decisive winner: stocks.

Since 1928, cash has beaten stocks 31% of the time over a one-year period. But as time goes on, the chance of cash beating stocks narrows significantly. In fact, there has never been a 25-year period where cash has outperformed the stock market.

This data isn’t particularly profound. The stock market goes up more often than it goes down, so more often than not stocks will outperform cash.

A bigger question is: What is it costing investors by sitting in cash?

In the short term, the opportunity cost is very little. On average, cash only underperforms the stock market by 8% over one-year periods. But the differential increases exponentially over time.

Over a five-year period, the difference between stocks and cash is more than 50%. Over 20 years, it’s more than 700%.

The lesson is clear: significant historical evidence shows the opportunity cost of sitting in cash is huge and grows over time.

No Need to Hike

The Fed’s November meeting came and went without any fireworks. As expected, the Fed held rates steady for the second consecutive meeting after 11 rate hikes prior.

While the Fed had been projecting one more rate hike before year-end, that may not be the case any longer.

The argument has been made the bond market already hiked for them as rates have continued to trend higher in the period since their last hike. A popular metric—30-year mortgages—are inching towards 8%, using data from Freddie Mac.

The good news is the market generally responds positively to Fed pauses.

Per Bloomberg, there have been six instances since 1970 where the Fed raised rates by over 100 basis points for a period of a year or more, then paused for at least 3 months. In every instance, the S&P 500 was positive, returning an average of 8.2%.

The Fed removing the lead from their foot isn’t the only good news—corporate profits are also trending higher.

Earnings Up, Outlook Up

The world seems to have a shortage of optimists right now.

Looking at Barron's Big Money Poll—a survey of professional money managers—only 12% of respondents classified themselves as “bullish” in October.

“Rarely have I seen such disarray in the world, with financial markets, politically, and otherwise,” said one respondent.

But one item that didn’t feature prominently among survey respondents: corporate earnings.

Earnings—or the future expectation of earnings—is the reason most investors invest in companies. Despite general pessimism, analysts are forecasting earnings to hit record highs over the next year.

We would acknowledge there’s a lot to be concerned about—this is always true! —but data continues to confirm job creation is robust, consumer spending is growing, and companies are investing in big projects.

All of this points to the possibility of more economic growth. And more economic growth helps drive profits, and profits are a reason the bull market that started last October may continue its path.

Bull Market Celebrates 1^st Birthday!

October 12 was the 1-year anniversary of the bear market bottom. The question looms: can the rally persist?

Recent data from Oppenheimer—analyzing historical data on bull markets—shows the second year is generally investor friendly.

Per Ari Wald, “Our analysis indicates year 2 following a major low has been positive in 19 out of 22 cycles (86% of the time; the misses occurred in 1932, 1947, and 1960), and we’ve found little relationship between year 1’s magnitude and year 2’s return.“

In short, it’s probably not time to quit stocks.