This month, Peter Mallouk and Jonathan Clements discuss how high demand, low unemployment, and supply chain disruptions played into the current bear market, what this bear market has in common with bear markets past and why market timing doesn’t work.
Hosted by Creative Planning Director of Financial Education, Jonathan Clements, and President, Peter Mallouk, this podcast takes a closer look into topics that affect investors. Included are in-depth discussions on financial planning issues, the economy and the markets. Plus, you won’t want to miss each of their monthly tips!
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Jonathan Clements: Hello, this is Jonathan Clements, Director of Financial Education with Creative Planning in Overland Park, Kansas. With me is Peter Mallouk, and we are Down the Middle.
The current stock market decline started back in early January. More than five months later, on June 13, the S&P 500 officially entered a bear market, meaning the index closed more than 20% below its early January peak. To many investors, 2022’s decline is starting to feel grueling, as if share prices will just keep gradually shedding value week, after week, after week. By contrast, the previous bear market in early 2020 was over in a flash. The peak-to-trough decline took less than five weeks, and the recovery was almost as fast. That raises the question, Peter, is there such a thing as a typical bear market?
Peter Mallouk: Yeah, they’re all very, very different. And I think if we look at the last five, it’s a great example. So if you take 9/11, the tech bubble, ’08/’09, the Trump tariff war with China and then the pandemic, 9/11, external event. Everyone cocoons, goes inside. The Federal Reserve’s response is let’s lower interest rates, and get people to come out, and spend money. The tech bubble, right before that, we go into recession. All these companies that don’t make money, it turns out stock can’t keep going up if they don’t make money, drag us into a recession. Fed lowers interest rates to get us out of the recession. We had ’08/’09, started with a housing crisis, financial instruments. The Federal Reserve lowered rates to try to entice people to go back to building homes, buying cars. Took a long, long time to drag us out of that recession, and it was the worst market crisis since the Great Depression.
Then, some people don’t even count it as a bear market. Trump and China got in a fight about tariffs. The stock market went down—barely touched 20% midday. It was a three-week drop in the market. Then, the market recovered. And then, you had the pandemic. No one knew what the mortality rate was going to be. Originally, 3% of people were gonna die. There’d be no way there’d be a vaccine. It turns out, fortunately, while it was bad, it was not what was anticipated early on. But what did The Fed do? The Fed lowered interest rates to get people to come outside and spend money.
So, they all have different causes, and they all have to do with people saying, “Hey, I’m not going to spend money.” Therefore, stocks go down because we don’t expect the stocks to have as much earnings if people aren’t spending money. And The Federal Reserve behavior has been well, let’s just entice people to buy stuff by lowering interest rates. Now, they do other things that have to do with the money supply, and Congress controls certain things. So for example, with the pandemic, Congress said, “Okay, we’re gonna give forgivable loans to businesses, bailouts to corporations, stimulus checks to everybody else.” So while The Fed is lowering rates to entice people, the Congress is giving people free money. And that combination just, surprise, caused inflation.
Now, I think what The Federal Reserve wasn’t expecting this time was supply chain disruptions. China still has lockdowns even as recently as last month, we have a war in Ukraine that’s driving energy prices up, there’s de-globalization, people are no longer going wherever something is the cheapest to make, and instead doing it in their backyard so they can control the supply chain. The Federal Reserve wasn’t anticipating any of that, and inflation got a little out of hand.
So what is different about this bear market? What’s different about this bear market is the economy is too hot. Prices are going up too fast. So, instead of The Federal Reserve doing what it did all these other ones for the last few decades, which is lower rates to entice people to go spend money, they are raising rates to discourage people from speculating. They’re saying, “Look, we’re going to raise rates so much that you don’t borrow money to buy your fourth house. We want you to think about it.” So, they want there to be some value tied to the dollar that’s predictable, and they want people to quit speculating for a lot of different reasons. So, the Federal Reserve behavior is the opposite this time of what we’ve seen in the past.
Jonathan: One sort of fun fact, I was just looking at the data, is that we currently have an unemployment rate of 3.6%. That is just barely above the 50-year low of 3.5%. You think of that—just above the 50 year low. I mean, people are out there they’re so pessimistic, they’re ringing their hands over inflation, and so on. And yet, in many ways, for a lot of families this is actually not a bad time. Anybody who wants a job can have one. In fact, you can probably have two.
Peter: That’s right. And you were joking about the probably have two, but it’s a fact because while the record low was 3.5%, we’re at 3.6%. This time, we have the largest job openings relative to the unemployment rate ever by a very wide margin. There’s two job openings for every person in that 3.6% unemployed. So the opportunity now is greater than it’s ever been. Now, what does that mean? That’s inflation areas. If McDonald’s wants to hire somebody, they have to hire ’em from Wendy’s. And if American Airlines wants to hire somebody, they got to hire ’em from United. They can’t just go hire an unemployed person. Everyone’s working so you have to pay them more to bring it over. You pass those higher costs onto the consumer. You get more inflation. The Fed wants there to be modest inflation, and unemployment that’s a little bit higher than where it is now.
I think what people are worried about, and people who have seen us talk would say, “Well, unemployment’s very low. What’s the problem? Why is there a bear market?” And it is so low and demand is so high, and there are still disruptions of the supply chain that you take the combination that The Fed lowered rates, Congress and the presidents have handed out a ton of money, and we have supply chain issues and immigration issues and everything else. You have unemployment so low and demand so high that prices are carrying to higher levels too quickly.
And as they’re raising rates, what’s different about this market isn’t just that. It’s that there’s a lot more outs here. So people are worried with the stock market because they’re saying, “Look, The Federal Reserve, oftentimes when they raise rates, they accidentally raise them too fast or too much. And then you go into a recession.” The home builder goes, “I’m not going to build as many homes.” The employer says, “I’m not gonna hire as many people because I’m not confident that, down the road, the economy will be strong.” So, that’s why the stock market’s reacting negatively that there won’t be a soft landing that the Federal Reserve will screw it up.
But what is different is that when you raise rates, you are making it easier to get out of a jam later. So with 9/11, the tech bubble, pandemic, ’08/’09, you have rates near zero. If another problem happens, well, what’s The Federal Reserve gonna do? I mean, it can’t take rates any lower. It can keep printing money, but it can’t take rates lower. Here, if they overdo it, if they mess it up, what are they gonna do? They’re gonna lower rates until they go back and right size this thing.
So, what we’re going through now is a short term disruption. The Federal Reserve, are they gonna land the plane perfectly on the runway? I’m pretty certain they won’t. Hopefully, it’s just a little bumpy, we don’t go sliding off the edge of the cliff. But they have outs here. They did not have outs, they did not have off ramps with the last four significant bear markets. And that’s another very big difference here.
The other thing I’ll say is we have never, in the entire history of the United States, had a severe recession with low unemployment. So, it’s very hard to manufacture a severe recession with the backdrop that we have.
Now, there’s always something that we’re not thinking about. Six months before a pandemic, we wouldn’t have thought about a pandemic. Six months before 9/11 we would’ve thought about 9/11. It wouldn’t even be contemplated in the discussion points. And that’s the real wildcard here. But if we’re just looking at the facts we have on the table today, look, might we have a mild recession? Maybe we’re already in it. We never really know ’til they’re over. And then, they give us the data that says that there was one. But this is nothing extraordinary. There’s a bear market, on average, every three to five years, depending on what period of history you want to pick. We’re in one now. If you’re losing your mind over this, I mean, and your 50, well, you’re gonna go through this seven more times, maybe more in your life, probably that are scarier than this one. So, I consider this bear market to be relatively mild, very hard to see a severe recession. And The Federal Reserve has a lot of ways out this mess if they screw it up.
Jonathan: All right so if bear markets, Peter, have all kinds of reasons, they follow all kinds of trajectories are there common elements, beyond the fact that, of course every bear market involves a 20% decline?
Peter: I think what they have in common is that people are pessimistic about the short-term future. People are looking ahead and saying, “I think these companies are gonna make less money two quarters from now, or four quarters from now than they are today. So I’m not gonna pay as much for them today, or I’m gonna sell them today.” Now 100% of the time, the market always recovers and goes on a new high. So, those people have better be really artful about when they exit, and when they get back in. But that’s really the common element that you have here is it’s not that earnings will be lower it’s that there is a belief from more people believe that they will be lower than believe that they will be higher. And that’s a big part.
Jonathan: Yeah, I think one of the mistakes I see numerous investors making right now is they look around and they say, “Inflation is out of control. Just had this 8.6% rate. People are worried about there being a recession. I should get out of stocks.” And it’s like, if this is what you’ve heard, if this is what the consensus thinks will happen it’s already reflected in stock prices. It’s too late to sell. It’s only if the news turns out to be worse than expected down the road that share prices will go down another leg. But if the news turns out to be not quite as bad as people fear, we may have already seen the bottom, who knows? So if bear markets have certain common elements, are there certain common ways that we should react each time around?
Peter: Well, I think you have to start with the belief system, do you believe that the economy is going to expand over time? That’s number one. And at Creative Planning we do. And then, the second is, do you believe you can time your way in and out of that cycle? Now, you could look at today, but you could also go back and look at the pandemic and ask, “Could I really have timed that? Could I have exited in early March and then got in late March?” Same thing with 9/11, the tech bubble, 08/09. I mean, can you know when to get in and when to get out? There’s a lot of research that indicates absolutely not. I’ve written about this extensively in letters, and my books, and so on. So, you start with the premise that the market goes up and down, but the economy expands over time. And so, the market will go up into the right over long periods of time.
And that second, you cannot time your way in and out of the short-term events, because the economy’s dynamic and a bunch of things happen that even if you had every fact in front of you and you were a genius, there can be one terrorist event, or something we’re not thinking about and changes all of the math. So you have to start with that as your secondary premise.
When you do those things, then you go, “Okay, I’m gonna to be a long-term investor. I’m gonna invest based on my goals. And when these things happen, I’m gonna take advantage of them. I’m gonna shift from bonds to stocks in the down market. I’m gonna place tax trades. I’m gonna own investments that aren’t correlated in advance of these things so that all my eggs aren’t in one basket. I’m gonna be global so if one part of the world is moving left, another might be moving right.”
That’s the approach is to have a needs-based portfolio, plan in advance, don’t be at the mercy of the market, and take advantage of the opportunities that the market presents to you. And do it every single time, even in great uncertainty like you had during the pandemic, or ’08/’09—even in that kind of intense uncertainty, you have to do it. That’s what we’ve always done at Creative Planning. And that’s how you are able to take advantage of these things, and not just get through it, getting through it is nice, but to actually be in a better spot when it’s over.
Jonathan: So it’s that time of the podcast, Peter, it’s time for your tip of the month. What have you got for me?
Peter: All right, all three of my kids are working this summer, so I’ve got one in college, and two in high school. And so, this is something that I like to do with the kids. So, you’re allowed to contribute to a Roth IRA up to the earned income. Well, anyone can contribute to a Roth IRA up to their earned income if they’re under certain income limits. So, the most you can put in Roth IRA is $6,000. So, if you’ve got a kid that’s working and this summer, they earn $7,000, $8,000, encourage them to put as much of that as they possibly can in a Roth IRA where it will grow tax free for the rest of their life, and come out tax free on their retirement.
Jonathan: And I guess I wouldn’t be insistent that the kid put all of, 100% of the Roth contribution out of their own pocket. I mean, maybe as the parent, in order to set the example, say, for every 25 cents you kick in I’ll put in 75 cents. I mean, what you want is more important than the money saved is the power of the example. And establishing that habit. And having the chance to have that financial conversation and say, “This is why you want to be in a Roth. This is what tax-free growth is all about. This is the sort of investment you might want to buy.” I mean, that conversation is more valuable than the savings themselves.
So, my financial wellness tip of the month, a lot of people are unnerved by the market decline that we’ve had. And so, what I would say to you is ask yourself one question, how long could I go before I have to sell any of my stocks, or any of my riskier bonds? If you’re still in the workforce and you don’t plan to retire for another 15 or 20 years, the answer is you’re probably not gonna have to pull any money out of your portfolio for 15 or 20 years.
If you’re a retiree and you have the next five years of living expenses, and short-term bonds and cash investments, maybe have another five years in intermediate term bonds, you can look at that and say, “Hey, I could go 10 years without selling any part of my stock portfolio in any of my even riskier bonds.” I don’t know about you, Peter, but 10 years, if the globally diversified stock portfolio isn’t up 10 years from now we have major, major problems far bigger than I can see out there. And I think it’s a pretty safe bet that you will indeed be okay over that sort of time horizon.
So, that’s it for us. This is Jonathan Clements Director of Financial Education with Creative Planning. I’ve been talking to Peter Mallouk, President of the firm, and we are Down the Middle.
Disclosure: This commentary is provided for general information purposes only and should not be construed as investment, tax, or legal advice. Past performance of any market result is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed.