I have recently returned from an annual Cambridge Investment Research advisor symposium, at which I attended a variety of presentations related to current market conditions. One of the speakers was Dr. Claus te Wildt, a PhD in Finance currently working at Fidelity Investments. During his discussion he
addressed the current correction, and offered his outlook for global stock market returns, inflation, and asset allocation. His thoughts were so clear and simple that I felt it was best for me to share the most relevant of his comments with you:
General Market Statistics
Equities will provide investors with an 8% average annual return over time. To achieve this return, you will need to understand and accept the terms of the journey. The market will be up three out of every four years. In each 3-year period you will see a -10% correction, during each 4-year period you will see a -15% correction, and over a 6-year period you will see one -20% correction. This is a very good value proposition.
Big corrections are always connected with a recession, we are not in a recession.
Ex China, global economies are in a mid-growth cycle.
Inflation and Its Root Causes
Short-term interest rates have climbed to 1.5% – and it is causing the financial markets to panic. Do those that are panicking truly believe that the U.S. economy will malfunction because short-term interest rates have risen to 1.5%? Is this some sort of shock to the system? Of course the answer is “no”, in fact interest rates need to go higher and this is a good thing. At this juncture, the only way for the Fed to tamp down on interest rates is to put the economy into a recession – and that would not be better than allowing the economy to accelerate.
Most of the current inflation is COVID related: as consumers switch from demanding goods instead of services. As COVID recedes, as it is doing *, consumers will shift back to demanding services rather than goods – then inflation will drop, by as much as half by the end of the year. Consider Peloton’s case as an example;
COVID caused the population to stay at home. Everyone wanted bikes. Peloton dramatically increased production, in fact had to have bikes shipped from China virtually overnight. Prices of bikes went up. As the world re-opened demand for bikes dropped. Peloton had way too many bikes. Now they are in trouble.
The labor participation rate has been on the decline during COVID. This will change, labor participation will rise – which will help growth in the economy. Interest rates will be able to float higher, but because it is growing on its own – not riding along with “training wheels”. * In the UK, COVID has gone from 20x more lethal than the common flu down to 2x more lethal than the common flu. So, the goal is not necessarily to eradicate COVID, but to get it down to 1x as lethal than the common flu – which the world can handle. The Effect of Higher Interest Rates on Stock Market Performance
The old adage on Wall Street, related to higher interest rates, is “don’t be afraid of the first rate hike- be scared of the last”. This means that the first few rate hikes are good, if the root cause is better economic performance. But the last rate hike is typically the Federal Reserve over-shoot and leads the economy into recession.
The S&P 500 produces solid gains after the 1st and 2nd rate hikes. Over the last 25 years, in the 12 months following an initial series of rate hikes the market (broken down by sectors) experienced the following gains: +20.0% Technology
+12.0% Real Estate Investment Trusts
+ 9.7% Health Care+ 8.3% Utilities
+ 7.8% S&P 500
+ 5.3% Financials
+ 4.8% Basic Materials
+ 2.0% Consumer Staples
Sector rotaon and bias in equity returns are driven by demographics – and COVID has not changed demographics in this country.
Higher growth and a shift from goods to services will lead investors back to large cap growth stocks (LCG)
– LCG will be a big winner over the next decade.
The two cheapest sectors in the market currently are large cap growth and small cap value – best to mix the two as the core of a well-balanced portfolio – avoid smaller “long duration” equities for a while (meaning small companies with the promise of high growth way out in the future.)
The stock market is “expensive” – but every asset class (most notably real estate) is expensive. Cash at a 0% return while the inflation rate is 7% is the most expensive asset of all. So don’t worry so much about expensive, high-quality equities that are cheaper on a relative basis.
Commodities and basic materials are in a secular bull market. At Fidelity they say, “everyone now loves copper, but hates copper mines.” Inflation in energy, commodities, and basic materials is more chronic – the inflation rate in other goods is transitory. So put more of your funds in an inflationary trend that will last longer. Global economies are demanding more commodities and basic materials.
Health care is a sector to over-weight. It has lagged the market because it is not a sexy re-opening strategy. But health care stocks are relatively cheap, earnings are steady, and there is a good deal of innovation happening in this sector.
Economic sanctions imposed on Russia will have a very harmful effect – and as such is a good deterrent. Russia will invade Ukraine, but it will be minor in scope as Putin is mostly looking for a show of force as their domestic economy reels.
Corrections during Presidential cycles are bigger than average; -19% in year 2. But the rebounds are much stronger as well; 12 months after mid-term elections the market rallies +30%. The market has never been down in the 12 months following mid-term elections.
These are the opinions of one market pundit, one team at Fidelity. But there is a good deal of common sense in these observations, and his perspective serves as a useful reminder that portfolio performance is better when we look ahead- and avoid the trappings of the current headlines.