Have you ever been worried to do something, so fearful that you lose sleep, that your stomach hurts? You know, like give a presentation or get on a rollercoaster. Then, you do the thing, and that thing you were so scared of really bad, wasn’t terrible at all? Well, we’re kind of in one of those scenarios with our economy right now. The Federal Reserve (Fed) has trumpeted its warnings of high inflation for a long time now, and increased rates at a record pace in the past year. This led to the backdrop that escorted in the new year.
Financial markets have experienced quite a bit of change this year in just two short months. We started the year hopeful that stocks would benefit from a better economic and monetary policy environment by the spring, but recent developments suggest that may be further out than initially thought. We remain confident that a new bull market will come—it will likely require patience to get there.
This hopeful bull market would have been prompted by the end of the Federal Reserve’s (Fed) interest rate hiking campaign. Those hopes were dashed following recent data pointing to stronger growth and higher inflation, and rate hikes may extend into the summer. Against that backdrop, even though the market took back some gains in February, this year’s modest two-month gain for the S&P 500 Index feels like a victory.
Recent evidence of consumers’ resilience has been encouraging. Over 500,000 jobs were created in January, according to the U.S. Bureau of Labor Statistics, nearly triple economists’ expectations (the February report is scheduled for March 10). The unemployment rate is at its lowest level since the 1960s. Retail sales rose a better than expected 3% in January month over month, as consumers benefited from the healthy job market and excess savings, while motivated by the diminished COVID-19 threat (with perhaps a small assist from mild winter weather). However, that consumer strength was accompanied by a series of hotter than expected inflation reports for January, fueling more concerns about higher interest rates and, in turn, weighing on the stock market.
Rewards for investors will come—with patience. In an environment where inflation has been frustratingly slow to come down, with a Fed still very much intent on combatting it, that patience is being tested. The risk that the Fed tightens too much and drives the U.S. economy into recession has risen. Higher interest rates also put stress on stock market valuations, so the longer we worry about the Fed, the less likely we are to see that bull market arrive this spring. Corporate America is not in a position to help much, given earnings declines are likely during the next two or potentially three quarters.
As Warren Buffett wrote in his latest annual letter to shareholders, “There has yet to see a time when it made sense to make a long-term bet against America.” Stocks have generated annualized returns of over 9% since the advent of the S&P 500’s predecessor index, the S&P 90, back in 1927—and that includes the Great Depression, World War II, the dotcom crash, the 2008–2009 financial crisis, 9/11, and numerous other economic and geopolitical shocks. Stocks may be volatile until the direction and ultimate destination of interest rates becomes clearer, but new highs will come—eventually.
A self-fulfilling prophecy: The more we worry, the more pressure we put on achieving success. The fear of a bad economy, a bad stock market and seeing our account values lower, is often times worse than the actual economy, stock market, or account value we get. Keep your sights on the long term, and you will be rewarded.