When markets are flying up and down like they’ve been doing, the last thing you want to hear is “You need to think long term”. Sometimes we need more than trite expressions, even if there is an underlying truth to our first-thought answers. So as advisors, we create (or copy) a narrative that sounds insightful and professionally researched. It provides something that sounds “reasonable,” makes us look smart, and helps make sense of the current situation.
We have heard the well-used reasons of inflation, slower earnings, and rising interest rates as the main culprits for the market uncertainty we are seeing today. There is truth in all these explanations. They are happening now, and they do have a direct effect on valuations. But most times the reasons for events occurring involve basic principles. These principles sometimes referred to as “first principles,” help identify the building blocks that can help us understand complex systems.
The term “things are different this time” is eventually scoffed at because most of the time, when things can be reduced to basic principles, we realize they are not that much different. One thing that never changes is we’re all human. We can’t get more basic than that. The fascinating thing about money and investing in the stock market is that it gathers up so many of our human emotions (and flaws) in one activity. Emotions such as greed and fear, anger, jealousy, prudence, fortitude, pride, and the big one – humility.
One different thing, at least since 2008, is the range of tools the Federal Reserve has used to navigate the ups and downs of the economy. This involves things like pumping money into or pulling it out of the economy through actions like Quantitative Easing (QE) or tightening(tapering). They can buy securities, which put cash (increasing liquidity) into the financial system or sell securities that pull cash (reducing liquidity) from the system. Reduce this down to a basic human behavior and we understand one thing. The emotions mentioned above can be amplified or curtailed when money is considered plentiful or in short supply.
We all know what happens when the Fed puts cash into the system. Just think about some of the massive monthly moves up at prices since 2008. But what about those times since then when the Fed has pulled back and reduced liquidity like they are doing now?
The following shows approximate times and market responses when they either attempted to either quit providing liquidity or reduce it:
APPROX. MARKET RESPONSE
|End of QE 1||Late March to early July 2010||Drops > 15%|
|End of QE 2||July to October 2011||Drops > 18%|
|End of QE||Late October 2014 to early November 2016||Drops > 13%|
|1st taper attempt||September 2018 to December 2018||Drops > 18%|
|2022 taper||January 2022 to ??|
The approximate market response refers to the SP 500 Index.
Do you know anybody that buys more of something they want when they think that the price of something they need will rise?
It is true that some prices were rising in early 2021 before the Fed talked about tapering. But broad inflation fears (remember when they called it "transitory"), and the resulting effect on stock prices, didn't really kick in until the Fed actually started their actions. We saw the immediate byproducts of those initial steps - increasing rates, broader inflation, and lower expectations. Now we are seeing the expected third and fourth order consequences - actual lower reported earnings and even lower projections.
None of the models, in any of our Strategies, contain an algorithm that tells you what to do for the future. The arena we work in is like life. We will never have the 100% clarity we desire. When we strip away all the comfortable but partially truthful reasons why something occurs, it comes down to human beings collectively making decisions through their own emotions and biases, allowing for what they perceive as risk. And the study of human behaviors is a field nobody has quite mastered consistently. Our economy and our financial institutions are in far better shape than they were in 2008. While our country has yet to make some tough decisions concerning our future, we are reasonably confident this is not the start of some prolonged market meltdown. As in life, when navigating the basic ups and downs that come our way, we are best served by accepting its conditional nature and striving to have a proper sense of proportionality as we move forward.
COMMENTS EXPRESSED ARE SOLELY THOSE OF PORTER INVESTMENTS AS OF THE 5/10/2022 AND ARE SUBJECT TO CHANGE WITHOUT NOTICE. OUR COMMENTS HEREIN SHOULD NOT BE USED AS THE PRIMARY BASIS FOR INVESTMENT DECISIONS, NOR IS IT ADVICE MEETING ANY SPECIFIC NEED YOU MAY HAVE. PLEASE CONSULT WITH US IF YOU HAVE FURTHER QUESTIONS ABOUT YOUR SPECIFIC SITUATION.