Why the Stock Market Must Crack

Why the Stock Market Must Crack

The Long Hot Summer is a perennial favorite movie in our house. Yes, our home is full of teenage girls, but films from multiple generations are often winners. As long and hot as this summer has been, I expected to find a relevant one-liner or two, but wouldn't you know it? Somehow both Paul Newman and Joanne Woodward failed to deliver.

Sure, there were plenty of quips about kissing, federal men, old dogs, and new tricks, but they left me high and dry, in terms of clever commentary about investing or financial planning — even in the abstract.

So, for today, I think I’ll stick with a topic I know and quote John Maynard Keyes ...

“Markets can remain irrational longer than you can remain solvent.”

I missed the calls recently due to a neck surgery (mine), and those same three teenagers starting school, looking at colleges, and chasing swim meets all over the country. So, let’s dive in.

In 2023, the S&P 500 is up 11%. The Dow Jones Industrial Average, by comparison, is up 2.5%. But at the writing of this article, they seem to be tittering on a precipice. Yet, the question remains:

Why are we (at Sound) not investing more in stocks?

Another one I hear is, "Why aren't we growing more?"

First, let me say I completely understand these questions.

Believe me, we have hammered our investment team more than once on the topic of the stock market, specifically. Today, in light of those internal conversations (all aimed at helping us to better serve you), I want to show why we think it is a bad time to buy stocks and try to chase risky growth. I realize this is contrary to the news. But we believe the data is showing something far different than the headlines.

Before I get started, this article was written in late September 2023. I am not giving anyone current investment advice. I am only speaking about our current client models. Moreover, I am not saying that you should not buy stocks ever again.

On the contrary, we think a day is coming when we absolutely think you should buy stocks.

But the time to buy is simply not now

In short, future forecasts for the S&P 500 (if we must use an index, let’s use the S&P) do not look good. Keep in mind regarding these are forecasts – no one, including us, can predict the future.

I simply Googled: 10-year S&P 500 forecast. The top five results gave me a prediction of an average annual return equaling approximately 7%. This average was of broad predictions made at different times of the year, some of which are not very scientific. But the internet is always right – yeah, right!

One of our favorite research firms, GMO, however, paints a different picture by forecasting -3% annual returns for U.S. large-cap stocks over the next seven years.[1] That is a dire forecast!

Quite frankly, (another boring but true disclaimer) I typically don’t write about forecasts because I firmly believe that none of the experts can predict the future. I know you’ve heard me say that a million times. But I like John Hussman’s work because he focuses on the numbers that matter most mathematically.

In Hussman's words:

“Valuations are the most reliable gauge of long-term market returns, as well as potential losses over the completion of any given market cycle.

A financial security (stock, bond, etc.) is nothing more than a claim on some future stream of cash flows that investors expect to be delivered into their hands over time. The higher the price an investor pays for those future cash flows, the lower the long-term return the investors can expect to enjoy. The relationship between current price, future cash flows, and investment return is just arithmetic.”[2]

Simply put, the stock market is over-valued by many indicators. The Buffet Indicator, reportedly Warren Buffett’s favorite metric, is 77% overvalued.[3] That’s high, folks!

My point is this — overvalued assets tend to have low to negative returns in the future.

Let’s go back to our Google search and try to determine a baseline expected return for large-cap US stocks. If you average a positive 7% annual return and a negative 3% return your (potential) expected return is 4% per year for US large-cap stocks for at least the next seven years.[4]

In my opinion, this is at best ho-hum and worse than that when you consider the risks.

What alternatives should you consider?

We'll keep it simple.

The Federal Reserve has raised interest rates higher than they’ve been in 20 years, which creates new investment opportunities for you. CDs, Treasuries, and Annuities are currently offering some of the best guarantees that I have seen in my career. And these can mix well within a model portfolio.

Compare the U.S. large-cap forecasts to the current 10-year US Treasury Note, yielding 4.5% per year.

You’ve probably already made the comparison in your mind. And you are asking yourself, “If predictions for U.S. large-cap stocks are to average 4% annually and I can earn 4.5% annually, guaranteed by the U.S. government, why would I risk my money in stocks?”

Great question! We are wondering the same thing.

The difference between the U.S. large-cap forecast and the US Treasury Note is called a risk premium – how much additional profit can be earned due to the extra risk an investor is taking. In this case, we are describing a negative risk premium of one-half of 1%.

In everyday terms, you would probably earn more owning a 10-year U.S. Treasury Note than U.S. large-cap stocks over the next seven to 10 years.

OK, let’s stop and think for a minute ...

No one should rush out and sell all their stocks

Don’t overload our team with liquidation orders. On one hand, we are dealing with a stock market forecast. I believe we should pay attention to these but not take them as law. And on the other hand, we have one of the best guarantees in the world, a U.S. Treasury Bond (insert your political jokes here).

What should you do? Use both!

Fixed-income options

First, we have the best opportunity in 20 years to take advantage of fixed-income options. In fact, these are the areas where we believe you should lock in growth opportunities — now and for years to come. If you have not done this, we need to talk. Interest rates affect everything in the financial world. And for the first time in over a decade, they are working in your favor. You should take advantage of these.

Keep a diverse portfolio

Second, keep a diverse portfolio. There are certain stocks that we like, such as dividend and certain international stocks. If you own these, which many of our clients do, we are not recommending that you sell them. We are just not that interested in purchasing much more at these stock market levels.

Now, I can hear some of you already wondering:

“Wait, Chris, you just said that U.S. large-cap stocks are set up for terrible to ho-hum returns over the next several years. Why shouldn't I sell them and put 100% of my money in the fixed return options that you are talking about?”

Again, I totally understand this question.

On the surface, it makes sense. But remember that no one can predict the future. And these new interest rates give us new investment opportunities. But you should never put all of your eggs in one basket. We should work with you to ensure that you are in a diverse portfolio that will help you reach your goals.

Which brings me to number three ...

What are your financial goals?

More specifically, have we worked on a financial plan together? If we have not, why not? Numbers one and two do not do you much good if you do not know what you are working toward. So, please set an appointment with your Sound Advisor and let’s make sure that you have a good plan and are taking advantage of some of these investment opportunities.

We also recommend you review a few of our financial planning resources (on your own or in advance of a conversation with us), so you can start looking ahead to a brighter future:

• Investment Strategy: The Sound Financial Way
• The 5 Pillars of Financial Planning, from Sound Financial
• Free Resource: Financial Planning Template

If you want to speak to me, the following is a link to my calendar: https://calendly.com/cmcalpin2020/30min. Or feel free to call our office for any of our advisors anytime at 601-856-3825.

I look forward to hearing from you soon.

Take care,

Chris

[1] GMO 7-year asset class forecast: July 2023

[2] https://www.hussmanfunds.com/comment/mc220707/

[3] https://www.currentmarketvaluation.com/models/buffett-indicator.php

[4] Comparing a mixture of different forecasts is not exact math. Our team does not make forecasts. These numbers and the entire article are for educational purposes only.