“Sometimes you need to take the bad with the good”. This cliche is typically used as an acknowledgement that “nothing is perfect”. Nothing could be truer when it comes to acknowledging the benefits of investing over time; you must accept the bad (short term market volatility) with the good (better returns over the long term). These types of markets are challenging to sit through, but they’re also why we believe so passionately in helping our clients develop a plan where we can use Monte Carlo as a stress test to map their desired outcomes. We feel it’s better to focus on achieving long term outcomes rather than be focused on short term volatility. The current market is not unlike others in the past because it contains a lot of noise that is distracting some investors from achieving their long-term goals.
So, what could be behind the current volatility creating risk with the stock and bond markets and the general economic conditions of the US economy and how worried should we be over the long term?
- Rising Inflation (highest in 40 years)
- Rising interest rates (they aren’t 0% anymore)
- Global politics (Russia and Ukraine War)
- Fear of Recession (caused by inflation and/or rising interest rates)
- Unemployment (Is it on the rise?)
- Other reasons
The talk or noise of today is that the US economy is currently experiencing the highest inflation in over 40 years (8.5% annualized), rising interest rates and a potential upcoming recession, all of which are seemingly combining to drag down the performance of the S&P 500 Index which is down 12.7% year to date as of May 5, 2022. Yet in 1980 the US economy experienced high inflation, averaging 13.5% and Fed Funds rate (short-term borrowing rates) at 13.39% and despite all that, the S&P 500 Index still managed to go up over 32%.
There may be many reasons for the current volatility, but one thing is certain, there has been a dramatic change in the complexion of the US Economy over the last 40 years.
Perspective, context, and historical stats are still important in understanding volatility.
The Dow Jones Industrial Average is a stock market index comprised of 30 companies that is supposed to represent the US Economy. Listed below is the makeup of the index in 1982 as compared to 2022. Only six names in the 2022 index were part of the 1982 index. How diversified was the economy in 1982 versus 2022?
The companies of the 1982 index would seem to be more impacted by interest rates, inflation, unemployment, and recession, however, those same factors didn’t negatively impact the performance of the stock market. Today’s market index represents a US economy that is more diversified than in 1982, yet we’re talking about the same issues that are creating short term uncertainty in our economy and volatility in the market index.
But what does it all mean for our clients in achieving their goals?
Perspective, context, and historical stats are important in understanding market volatility, but asset allocation and diversification in portfolios for the long term is preferred over being sidetracked by market noise. Sometimes, you need to take the bad with the good when you invest for the long term. These types of markets are challenging to sit through, but they’re also why we believe so passionately in helping our clients develop a plan where we use Monte Carlo as a stress test to achieve their desired outcomes. We feel it’s better to focus on achieving long term outcomes rather than be focused on short term volatility. When put into perspective, the first five months of 2022 is a blip on the radar of a long-term horizon and Monte Carlo helps to keep that both in perspective, as well as identifying plan weaknesses that might derail those long-term desired outcomes.
Sources: US Bureau of Labor Statistics; Federal Reserve Bank; Slickcharts.com; MacroTrends.net; CNBC; Dow Jones Industrial Index
