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Investing

When it comes to investing, look ahead instead of in the rearview mirror

Yin and yang. Salt and pepper. Hall and Oates. Markets and the economy?


Yin and yang. Salt and pepper. Hall and Oates. Markets and the economy?

Like the aforementioned pairs, you don’t often hear talk of what’s going on with markets without mention of what’s going on with the economy, and vice versa. But also like the aforementioned pairs, markets and the economy aren’t one and the same.

Various risks – like hot inflation, an ultra-aggressive Federal Reserve, war in Europe, sputtering growth in China, etc. – loom over the outlook and can lead one to believe the U.S. could be headed for a recession in 2023. However, it’s important for investors to understand both the interplay and the distinction between markets and the economy.

Here are the punchlines:

  •  Stock and bond markets are forward-looking machines, with prices that reflect what investors think may happen to the economy in the future.
  •  In all but one of the past eight recessions, the stock market found its bottom while the economy was still deteriorating.1
  •  For as painful as 2022’s selloff has been, it has created potential: Today offers, in our view, one of the best entry point for a diversified portfolio in over 10 years.

Markets are forward-looking

2022 offers a helpful example of the relationship between markets and the economy. The market started its decline back in January, and crossed the bear market threshold (-20% from highs) in early June – a time when the unemployment rate was just 3.5% (near historical lows), consumer spending was still growing at a solid clip and both services and manufacturing surveys suggested continued economic expansion.2

The point is that the economic backdrop looked relatively healthy and resilient, with one particular (big) caveat: Inflation pushing economy-wide prices higher at the fastest rate in over 40 years.3 The inflation problem and the Fed’s response to it (i.e., aggressive rate hikes in rapid succession) are at the root of 2022’s market turmoil because of how investors expect elevated interest rates will hinder economic activity going forward.

Investors pore over economic data because it can be useful and important in identifying directional trends and economic turning points, but it’s backward looking; it tells us what happened in a current period.

For investors, it’s kind of like driving a car. Do you keep your eyes on the rearview mirror, or the road ahead of you?

The time to consider investing may be when it feels like everything is getting worse

Today’s market prices reflect the amalgamation of investors’ expectations about the future. As consensus sniffs out a possible recession to come, markets tend to decline in anticipation of a contraction in economic activity, which can hurt consumers and businesses and low or negative profit growth for the companies people invest in.

Looking at history reveals an important takeaway. The stock market tends to bottom while the economic backdrop is still deteriorating. In every recession of the past 50 years – except the Tech Wreck in the early 2000s – the S&P 500 began its climb back to highs before economic activity troughed.4 In the median occurrence, the market rally began about four and a half months before GDP found its low point and generated 30% upside in that period.5

At this point, the general consensus amongst market participants is that the U.S. is likely to enter recession in the next year, possibly bringing job layoffs, a rise in bankruptcies and an erosion of corporate profitability. But it’s when the outlook perhaps feels the most bleak that investors should remember what eventually comes after: recovery. It’s always darkest before dawn, and history suggests that getting or staying invested when sentiment is as bad as it’s been in 2022 can offer compelling rewards. 

This year’s pain has revealed potential

Going back to the 1970s, there have been just nine episodes of stocks selling off as much or more than they have in 2022.6 The S&P 500 doesn’t go “on sale” like this every year. What’s more exceptional is the concurrent and dramatic selloff in core bonds – in fact, it’s having the worst year of performance on record.7

What it can mean is that investors have the luxury of choice. These attractive yields can be found in high quality segments of the fixed income market, like investment grade corporate bonds and high credit quality municipal bonds.8 By merely recovering back to its high where it started the year, the S&P 500 could generate a cumulative total return north of 25%.

 

Getting here hasn’t been fun, and there could be more volatility along the way. It is believed that investors have a compelling cross-asset class entry point in over a decade.

1.FactSet, Bureau of Economic Analysis, Haver Analytics, J.P. Morgan. As of Sep. 2022.
2.FactSet, Bureau of Economic Analysis, Haver Analytics, J.P. Morgan. As of Sep. 2022.
3.FactSet, Bureau of Economic Analysis, Haver Analytics, J.P. Morgan. As of Sep. 2022.
4.FactSet, Bureau of Economic Analysis, Haver Analytics, J.P. Morgan. As of Sep. 2022.
5.FactSet, Bureau of Economic Analysis, Haver Analytics, J.P. Morgan. As of Sep. 2022.
6.Bloomberg Finance L.P. Data as of October 31, 2022.
7.Bloomberg Finance L.P. Data as of October 31, 2022.
8.Bloomberg Finance, L.P. as of Nov. 2022. References Bloomberg Global Aggregate Index and Bloomberg Municipal Bond Index.

 

IMPORTANT INFORMATION

Investment trends may not materialize. Sustainable Investing and investment return are not always aligned, and may lose value.


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