Have We Climbed the Wall of Worry?
“The key to a happy marriage is low expectations” – Charlie Munger, Warren Buffett’s sidekick
How many times have you purchased a stock that seemingly could not miss? Only to be disappointed when the overhyped rocket crashed to the ground. On the other hand, you have that old stock you bought 20 years ago that never seems to make the headlines, but increases its earnings and dividends most years. If you have been a customer of Monarch for a long time, you will know we are a lot more interested in the unhyped stock than the rocket. There is an interesting statistic related to long-term performance in the stock market. If you missed being in the market on its best 20 days over the last 20 years, your performance would drop from +10.4% to +3.5% annually. That means taking out just 1 big up day per year (on average). The next two graphs show the S&P 500 for the year-to-date (6 months) and the last 5 years. If you invested in the index 6 months ago, you would have suffered a couple of emotional whipsaws…at the market low on April 8, the Dow Jones was -14%, the S&P -20%, and the Nasdaq -23%. But, thanks to the late rally in the market in June, you ended up with a positive return year-to-date. April 8 would have been a bad day to sell out of the market, as the market shot up 9.5% on April 9.
If you invested 5 years ago, you would have also experienced a bumpy ride, but your results would have been much better. Over those 5 years, your investment would have practically doubled in value. I (actually Adam) calculated what would have happened over the last 5 years if you had invested $1,000 on June 30 each year for the past 5 years, into the S&P. On average, you would have a roughly +17% annual return. Going back 50 years, the average is +10-12%, so the last 5 years are above average. Chart is below:
I think I know what you are thinking – enough with history; what is the market going to do for the next 6 months? There are many moving parts, but market sentiment is pretty important. The following graph is from Schwab’s Chief Investment Strategist, Liz Ann Sonders. She breaks sentiment into two indices – soft data is what people are thinking and hard data is what they are actually doing. You will notice the lines diverging, as soft data (orange line) have plunged and hard data (blue line) remain pretty strong.
There is another index which was created in the 1970s, when we had real inflation. It is called the misery index, which is the sum of the inflation rate and the unemployment rate. The graph below shows the present misery index (blue line) at a very reasonable level, around 6%, but the one-year expected misery rate (orange line) has shot up to levels seen only in 2008-09, exceeding 70%. The inflation expectation is roughly 5%, leaving roughly 67% as the net number of respondents expecting unemployment to be higher in a year. Higher unemployment does seem like a rational expectation, although should it be alarming that this series has hit levels only seen at the outset and in the depths of the financial crisis? This is the quintessential soft data series—it may not indicate that unemployment is about to shoot up (indicating the economy is tanking), but maybe is a better read on the bearishness of the average American consumer.
It is said the market climbs a wall of worry. Today there appears to be plenty to worry about, and yet the market is at a new all-time high. While this may not seem logical, the market quite often trades in mysterious fashion. On the other hand, many would say the market is fully valued today. Is it possible for these observations to be simultaneously correct? As we mentioned earlier, keep your expectations reasonable. When those corrections come, call John and George.
– Written by Dave Meyer
