Are You Stocked?
Greetings from San Diego! I am at the Investments and Wealth Institutes Annual Conference, my favorite investment planning conference each year. By the time you read this, I will very likely be back at my desk in Jacksonville.
To my delight, this year’s keynote speaker on day one was Dr. Jeremy Siegel, the Russell E Palmer Professor of Finance at Wharton. On my very first day on the job as a financial advisor more than 20 years ago, my mentor gave me a copy of Dr. Siegel’s seminal work, Stocks for the Long Run, published in 1994. It is now in its sixth edition and has been named one of the 10 most important investment books of all time by both BusinessWeek and the Washington Post. I am not overstating things to say it has been one of, if not the most influential books in my career. Dr. Seigel told me this edition is way better than the original (Ha!). I can’t wait to read it.
In his keynote, Dr. Siegel had a lot to say about the Fed, interest rates, the banking crisis, and the markets, which I will be integrating into our thoughts going forward. For the purpose of this email, I will simply share a few of his comments starting with how he said he answered a reporter when she asked him to summarize his book in just a few sentences. He said he did so with the chart below and this quote:
If you aren’t familiar with this chart, it is a logarithmic chart, meaning a line that moves up in a straight line represents a constant rate of change. Log charts are used when the numbers in the chart grow exponentially. Notice how the scale of the vertical axis changes, first at $1 per unit, then $10, until they are growing at $1 million per unit towards the top of the chart. If we used a normal chart where the scale was constant, you wouldn’t be able to fit stocks on the chart with the other types of investments. In the case of stocks, they have grown at an annual rate of 6.9%.
The chart is also what economists refer to as REAL returns, meaning it is the rate of return above inflation. As you can see, over the long-run, not only do stocks have the highest rate of return, but they also do so seemingly totally unaffected by changes in inflation given the straightness of the line. No other asset class has consistently done so. Obviously, in the short-term stocks are very volatile. In fact, as we saw in 2022, stocks can be dramatically impacted by the Fed’s short-term reaction of raising rates to fight rising inflation, but over longer periods stocks have consistently returned about 7% above inflation. Amazing!
While Dr. Siegel is not a proponent of market timing, I think it is fair to say he is optimistic about potential long term stock returns today. His central thesis being that the Fed is likely done or very nearly done with raising rates, which has been a big headwind for stocks. He argued the Fed has made a big mistake raising this much already. Much of his talk centered around the Fed’s mismeasurement of housing data, which comprises about 40% of the inflation number we see published each month. The Fed uses a data source for housing that was developed in the early 80’s and is about 8-12 months slow to reflect the actual real time changes in housing costs. We now have more real time data sources that the Fed inexplicably is ignoring. When using the real time data, Dr. Siegel pointed out that inflation has been negative month over month for the last 3 months. Note this is not to say inflation is slowing, but that prices have been falling. Moreover, using real time data, the year over year inflation number in March was just 1.8%, already below the Fed’s 2% target. When or if the Fed will recognize this is anyone’s guess. The biggest risk right now is that the Federal Reserve will harm the economy by doing too much.
As to stock timing in particular, the best data presented at the conference was from JP Morgan Asset Management’s Chief Investment Strategist, Dr. David Kelly. The chart[i] he shared below is the University of Michigan’s Consumer Sentiment Index, which is a survey that measures how consumers are feeling about the overall state of the economy, markets, and their personal financial situation. Dr. Kelly’s team has added the return for stocks the following 12 months after peaks and troughs in the public’s financial confidence.
When confidence is highest, that is to say people feel good, the subsequent 12-month stock returns have been a paltry 3.5% and when it is lowest, which is to say people feel negative, stock returns have historically been an impressive 24.9%. Of course, no indicator works every time and past performance is not indicative of future performance. Perhaps even more importantly, we don’t know when confidence has peaked or bottomed until well after the fact. With that said, I would say that in my career I have concluded that the best time to invest is when no one wants to invest and the worst time to invest is when everyone is confident things are great. Intuitively, if you are reading this email, you likely know this…this chart quantitatively demonstrates it.
Will history repeat itself this time around … I honestly don’t know. No one knows the future. I am optimistic history will repeat again and my money is where my mouth is. I believe we just need to have a long enough perspective.
Authored by
Jason Hyrne
[1] Source: FactSet, Standard & Poor’s, University of Michigan, J.P. Morgan Asset Management.
Peak is defined as the highest index value before a series of lower lows, while a trough is defined as the lowest index value before a series of higher highs. Subsequent 12-month S&P 500 returns are price returns only, which excludes dividends. Past performance is not a reliable indicator of current and future results.
Guide to the Markets – U.S. Data are as of April 30, 2023
Wells Fargo Advisors did not assist in the preparation of this report, and its accuracy and completeness are not guaranteed. The report herein is not a complete analysis of every material fact in respect to any company, industry or security. The opinions expressed here reflect the judgement of the author and are subject to change without notice. Any market prices are only indications of market values and are subject to change. The material has been prepared or is distributed solely for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Additional information is available upon request.
The S&P 500 Index consist of 500 stocks chosen for market size, liquidity, and industry group representation. It is a market value weighted index with each stock’s weight in the Index proportionate to its market value.
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