October Newsletter to Clients

Enjoy this month’s edition that features our guidance on the upcoming decade and some market history for the short-term.

The Stanford economist, Paul Romer, once said, “A crisis is a terrible thing to waste.” What he meant, of course, is that market downturns and periods of uncertainty often present opportunities. We believe 2022 is just such a period and that some fundamental changes present opportunities for the next decade.

First, a little background since the 2008-09 great financial crisis where we experienced a slow-growing economy, low inflation, and very low interest rates. We also saw amazing stock market performance with the S&P 500 returning an average annual rate of 16% from then through 2021. Those lower interest rates meant cheaper borrowing rates for fast-growing companies. They also meant that so-called growth companies, those expected to generate a greater share of their cash flows in the future rather than now, had those cash flows discounted at a lower rate, resulting in higher stock prices. Think companies like Amazon and Tesla that were growing at high rates but not yet producing reliable earnings.

Fast forward to today and we’re experiencing the opposite with a hot economy, high inflation and higher interest rates. It’s reasonable to expect that a different environment will produce different winners. So, what does that mean for you?

As you know, we always have and always will focus primarily on structuring our clients’ portfolios and investments in ways that best fit their individual circumstances and goals. Within those structures, however, are opportunities that we will attempt to leverage, such as:

• Actively managed mutual funds: Over the last decade and a half there was a popular narrative that simply investing in mutual funds that mirror an index such as the S&P 500 of large, U.S. stocks was superior. We, however, have always believed in using the expertise of mutual fund managers who can better pick winners and, maybe even more important, avoid the duds. Going forward, we believe selective stock selection will be even more important;
• Value mutual funds: With higher interest rates projected over the next several years, those growth stocks that performed so well when rates were low will face tougher sledding. We believe value stocks, companies that have strong cash flows now with consistent dividends, may perform better in a higher-rate environment;
• Shorter-term bond mutual funds: Similarly, bond mutual funds with shorter durations – a collection of 2-5 year bonds rather than 30-year bonds – and good credit quality should perform well in this new environment;
• International mutual funds: Almost all of our clients hold international stocks through one of our mutual funds as we believe that’s an important way to diversify. Valuations are cheaper for companies outside the U.S., so we’ll continue to hold and maybe add to our international holdings.

What to expect the rest of this year and next:

As you know, no one knows how the stock and bond markets will perform in the short-term. Having said that, it can be interesting to examine past market performance for clues on the future:

• Out of the 10 worst starts to a year for the S&P 500 since 1950, 2022 has been the third worst. A year later? The market was higher 8 of those years with a median return of 25.5%. 2001 and 2008 were the exceptions;
• On the flip side, according to Bloomberg, if the end of September was the bottom of the bear market, stocks would have been the most expensive bottom of the market since at least 1957. The average Price/Earnings ratio at the bottom was 12.6; the current P/E ratio is 17.9, which may mean we haven’t yet hit bottom.

 Thank you for your continuing confidence.