The Financial Advocate: Spring 2022
Goals and Time Frames
In our last newsletter we discussed the idea of “price discovery.” Needless to say, if you have been watching the market’s gyrations in the months of April and May, price discovery is in full bloom! Daily volatility, massive price swings, and wide-ranging forecasts have made for one of the worst starts to a year. Investors have a lot to digest. Rising housing prices, increasing interest rates, high inflation, supply chain disruptions, war in Ukraine, COVID’s lingering impact (including lockdowns in China) – all have played an important part in creating a volatile start to 2022.
The purpose of this letter is to address the issues we have outlined, but more importantly to help you keep focused, calm, and effective in moving forward financially.
Yes… year-over-year home price increases are at 20%!
Some builders have said that due to labor, material costs, supply chain disruptions, and shipping costs that building a new home costs 30-35% more than a year ago. We largely believe this to be true. While all of these factors are important, there is also a demographic problem and structural issues. Demographically, the Baby Boomers are a large cohort (about 68 million people) that are currently in, or rapidly approaching, “retirement mode.” If we looked at longevity tables 20-30 years ago, this age group were going to retire, downsize, and spend about a decade or so in retirement before leaving this earthly domain. Well – that’s not happening! Baby Boomers are largely not downsizing, not selling their homes, and planning on living a healthy 20-30 years in the next phase of their lives. Medical advances have allowed this generation to live healthy, productive retirements and many of them are choosing to stay right where they are. Enter the Millennials, another massive age cohort (approximately 90 million individuals). They are entering the peak consumption time of their lives. They are looking for homes, cars, and neighborhoods to start families … and what do we find? Not enough of any of those things! The financial crisis of 2008 (blamed largely on speculation in housing) led to a fifteen-year drought of new homes being built. It is estimated that we need millions of new homes to meet demand. This problem is going to be around for a long time. One of the reasons this has such a substantial impact on our current environment: it is estimated that housing and related expenses (which are currently inflating) use up about 40% of the average household’s income.
Interest Rates and Inflation
At this point many of us probably feel that the COVID-19 pandemic changed our lives in many ways. Our responses to the pandemic were wide ranging and profound. The government’s economic response to the shutdown of the world’s largest economy was to throw money at it! This did keep our “stay at home” economy afloat, but it has created an inflation problem that is lasting longer than many economists initially predicted. We are in a situation where there is too much money chasing too few goods! While demand for goods delivered by Amazon is currently falling, the price of an airline seat is up big, cruise lines are selling out, and Live Nation reports booming sales for live events at almost any price. Let us be direct – the government method to calm this inflation is – demand destruction. By raising interest rates, everything becomes more expensive, thus theoretically lowering demand. This is a very delicate exercise, if they destroy too much demand, we have a recession. If they don’t destroy enough demand, we have spiraling inflation. This is the number one issue affecting the financial markets today. Rates are going higher; but will it cause recession? While still low, odds of that possibility are rising.
The war in Ukraine is a tragic and horrible event. While a humanitarian disaster, it also has a wide range of economic consequences. Ukraine and Russia create about 25% of the world’s supply of wheat. Much of that is not being planted or making its way into the global food supply. Together, they also create about 40% of the world’s fertilizer. Prices for fertilizer are through the roof – making the world’s supply of food more expensive for everyone. As you know, Russia is a major producer of fossil fuels. Disruptions to supply, international sanctions, and “risk premium” have caused energy prices to soar. Anyone, travelling anywhere or shipping anything, is paying the price for this. Driving your car, heating your home – starkly more expensive. Add to this China’s “Zero COVID” lock-down policy. Two of China’s largest cities are feeling the consequences of this process as we pen this letter. Supply chains for everything from raw materials to semiconductors flow through these cities and their ports. Delays, shipping issues, workers – all are disrupted. What does this mean? Higher costs for a longer period of time. We should note that many economists believe that we are entering “peak inflation” in the later spring or early summer. How quickly inflation levels even out will be a key indicator as to whether or not the period of economic growth we are experiencing will be able to continue.
We are at the time in this cycle where the markets are in a “fear mode.” Stocks are down and investor’s traditionally favorite hiding spot – bonds – are down just as much. Commodities are up, but performance has been very volatile, as are cryptocurrencies. Precious metals are mostly stable. Today, the S&P 500 is in a “correction” and the tech-heavy NASDAQ is in “bear market” territory. The only reliable asset is cash, but with inflation at a current 8.5%, cash is a guaranteed loser. It is important to remember that an index like the S&P 500 usually has a 15% correction at least once per year. What is making this correction feel much worse is that it is occurring at the start of the year and that the market had been very well behaved since the lows set early in the pandemic.
The cross currents right now are huge. Watching the markets daily is like sailing in rough seas during a hurricane! One factor that we believe is contributing to the high volatility we have been is experiencing is that there is a lot of good news out there! If everything was just plain bad, markets would be moving straight to the downside.
Unemployment is near a half-century low, workers are experiencing rising wages, the US consumer’s debt service ratio is at a 40-year low. Savings rates are up, COVID has become more manageable, and there are glimmers of hope that some supply chain issues are improving. Corporate profits for this quarter recently reported are up 10% for the quarter! Stocks should be higher, but the market is looking forward and is fearful of that recession we discussed earlier. But, a recession at this point is not a foregone conclusion.
What you should do is look forward as well. Not just with the market but also with your own personal goals.
Back to basics
Why do you invest money in the first place? Most would say for “future goals”: buying a house, investing in a business, retirement, education, bequests to a future generation – all of these are valid goals that we assist clients in planning for every day. What’s your time frame? You can look at times of volatility with fear or opportunity. What happens in market shake-outs is that some assets become mispriced. This creates opportunity for the buyer of those assets who has the time to let issues return to a more stable period. Great buying opportunities in the investment markets almost always occur in periods of uncertainty and disruption. When buyers are scarce and sellers are plentiful, prices fall. If you know what you are trying to accomplish and you are confident in the quality of what you are buying, then the only other variable is time.
A famous stock investing quote is: “Buy when there’s blood in the streets, even if it’s yours!” This principal applies to today. No one can dispute the power of the American consumer, the innovation of American business, disruption from artificial intelligence and smart machines, the electrification of vehicles, the transition to renewable energy – the list goes on and on… We are fairly certain that we will soon have a clearer picture from the Federal Reserve as to their plan for inflation control. That will add some clarity to the investment landscape. Overseas events are believed to remain volatile, and we will have to manage them as best we can. We would argue that you can tilt in the direction of current market favorites; but be mindful that true wealth is built over time by investing in great companies that grow year after year.
Remember, members of the VWM portfolio management team have successfully managed money during the chaotic 70’s, the roaring eighties, the Crash of ‘87, Desert Storm, the booming nineties, the Tech Bubble, Globalization, the Housing Crisis, and the pandemic. Add in some currency crises, various government defaults, inflation, deflation, and even presidential assassination attempts. We work with the information we have. We work to control risk. We buy healthy dividend payers. We look for mispriced opportunities. And in actively managed portfolios, we build in a wide degree of diversification to mitigate volatility while adhering to individual financial plans. That’s how you survive financial storms!
This quarter’s financial planning topic is “risk assessment.” Often, when volatility increases it reveals that an investor or household’s risk tolerance may have shifted. This happens with some frequency and is important to recognize. Sometimes, as we get closer to retirement, our risk tolerance lowers. (For some people, it actually goes up!) Neither is technically “right” or “wrong.” However, it is important to ensure that the risk of the portfolio is aligned with your own personal risk preferences.
While at VWM we encourage our clients to focus on the percentage change of a portfolio, we recognize that some people look at the change in the value of their portfolios in terms of dollars. (This is very, very easy to do!) As we mentioned previously in this letter, the S&P 500 has an average annual correction of about 15%. So, what we are currently experiencing in the investment markets is something that many of you have experienced before. Does that make it any easier? Of course not. What may be increasing your anxiety more today than in years past is the size of your portfolio. Actively managed accounts have done exceptionally well over the past five years – even factoring in this current drawdown. As such, the dollars in the accounts are larger. That means that a 10% decline in portfolio value is likely to be a bigger number than you experienced in the past. For example, let’s say your portfolio averaged 8% returns for the past five years. If you suffered a 10% decline today, in dollar terms, that 10% is close to 50% larger than it was five years ago. That means that psychologically, this pullback might hurt more than previous declines. If you are experiencing higher anxiety than you have in the past because of current volatility, we are here to help by discussing current strategy, your financial plan, and helping to clarify financial goals.
Your Retirement Plan
We are happy to assist with financial planning advice, help make investment selections, and discuss your investment portfolio. Please reach out to Dan McElwee at 609-671-9100 or firstname.lastname@example.org for any of these matters.
Nick Ventura, CFP® CPWA®
President / CEO