What is going on with the market?
It is still wild times indeed and volatility continues. The bear market is upon us. Buckle up, but brace yourself to make it through unscathed.
There’s nowhere to run with stocks down, bonds down, crypto down, inflation eating away at cash, and currencies depreciating vs. the dollar.
And we rarely see the Fed raising rates into a bear market or a recession.
So, what should you do?
First, hopefully your portfolio was prepared for this. You should always be prepared for a market crash as if it is going to happen tomorrow. Don’t try to predict it. Chances are you will time it incorrectly.
If your portfolio is not prepared for the bear market, then there are things we can do to help you weather the storm. Feel free to reach out.
How can you be prepared? Always set up your portfolio so it is ready for a market crash, regardless of when the market crash occurs. Have holdings in cash or cash like positions so that you don’t have to sell in down markets for withdrawals. It is more nuanced than this, but this is the general premise.
How long could this last?
We are around eight months in, and the current bear market is now the longest we've seen since the 2007-09 bear. The average length of a bear since 1929 is 14 months with much variation around that number (ex: the 2020 bear was only one month; the 2000-02 bear was 31 months).1
So, what about the good news?
- First, this.
- There tends to be a bounce after midterms. More on that here.
- Historically, now (during bear markets) is when big returns are made long term.7 Be greedy when others are fearful.
- The Fed raising rates during the good times like we just had can be a good thing. The Fed is hyper aware (surely) that there are unknown unknowns (black swans) that can blindside the market. It happened with the Pandemic and the Great Financial Crisis. It wants to have a tool in its back pocket to address these events. That tool is to lower interest rates. It can’t lower from zero. So, by raising rates now, it has a starting point from which to drop rates later. Pair that with the fact that raising rates helps fight inflation. Hopefully the Fed gets that under control, too.
Hopefully the Fed knows what it is doing.
The US Government, like any other entity, needs to pay interest on its debt. With rates rising, its debt payments rise, too. As of August 2022, it costs the government $677.6 billion to maintain the debt, which is 12.66% of the total federal spending.2 It was 9% back in 2021.3
With rates up along with government debt service, it makes you wonder why the US didn’t refinance its debt when rates were zero by issuing bonds with extra-long maturities. 100 years might be steep, but it was considered. Yellen said no apparently.7 Right now, it doesn’t seem like such an awful idea. I’m sure there are tons of other repercussions, not excluding what our grandkids might think of us.
Regardless, the great experiment is ending. For now, at least. Money is expensive. Portfolios are down. Inflation is up. We are trying to get back to normal and it hurts. People will owe more money for auto loans, credit card debt, variable rate mortgages, security backed lines of credit, you name it. Therefore, they’ll spend less elsewhere wherever they can. More will be spent on groceries because we have to eat. Perhaps less will be spent on the new iPhone.
Hopefully rates don’t rise so much that something breaks in the financial system. What could that be? The UK might’ve given us a glimpse. Hopefully the Fed knows what it is doing. It’s been wrong before - inflation was not transitory. Hopefully it’s not wrong again by continuing to raise rates after possible peak inflation. Hindsight is 20/20 and perhaps it should’ve started raising rates earlier and in smaller increments.
If something does break, at least rates will be high enough that the Fed can drop them again to help ease the pain.
The Fed needs to control our expectations
Part of the psychology of markets and inflation is that the Fed not only needs to control inflation and interest rates, but it needs to control the people's expectations of them. Expectations of where inflation and interest rates are heading affect the reality of where interest rates and inflation go. Therefore, the Fed needs us to believe that it will raise rates further and further and that inflation will come down. For if we believe that, then we will stop spending. If we believe the price of a car will stop going up, then we won't rush to buy one now at a lower price. Instead, we’ll put off the purchase to a later date. If that happens in mass, then there is less demand for cars and the price declines. Inflation cured.
And if we believe that rates are going up, then markets will go down because stock prices will be re-priced lower. More on that here. And if markets go down, we will feel poorer and therefore spend less. And again, if we spend less, then inflation is cured.
See #4 below for another eye-opening viewpoint.
With all this wild news, let’s remember we have seen this before. Looking at history, bear markets have always come back to future gains.5
One last thought for now… There’s “a lot of talk how this year looks a lot like 1962. New Democratic President, midterm year, supply chain issues, Cuban Missile Crisis, etc. The S&P 500 didn't bottom until Oct 23 that year, but did see a 19% rally into the end of the year.”
This reminds me of more nuances:
1) Records are meant to be broken.
2) History rhymes, it doesn't repeat. It is no guarantee of future results, but it is still helpful.
3) Things that have never occurred before happen all the time (Black Swans).6