This month, Peter Mallouk and Jonathan Clements discuss how this bear market differs from others in recent history, what options to consider if you have extra cash to invest and why you might want to rebalance.
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: This is Jonathan Clements, Director of Financial Education for Creative Planning in Overland Park, Kansas. With me is Peter Mallouk, President of the firm. And we are Down the Middle.
During trading on Friday, May 20, the S&P 500 briefly fell into bear market territory, dropping 20% from its early January all-time high. The media were ready to trumpet the bad news, but then stocks rallied before the market closed, so we never officially entered a bear market. That rally continued into last week and suddenly everything seems a little happier in stock market land. So, Peter, do you think the worst of the stock and bond market decline is over?
Peter Mallouk: I think it’s really complicated. So let’s look at the last few bear markets, let’s go back to the tech bubble, markets down 44%, 48%; you go to 9/11, again, 40-something percent; you go to ’08/’09, the worst one since the Great Depression, bottomed at down 53%; those were U.S. numbers, the rest of the world did much worse in all three instances. Then you get to the pandemic. You finally have what I’d call a somewhat normal bear market, at least in terms of percentages — it was down 34%, 34%’s actually an average bear market, but it felt much worse than average because the market went down 34% faster than it ever had in all of history. So it was traumatizing; we were all at home watching it unfold, because we had nothing else to do.
Now, what all those had in common is there was one big thing that happened. So, 9/11, one terrorist event; tech bubble, we have the dot-com inflation; pandemic; all of these things had one big event. And then the Fed came in and the Fed helped by lowering rates and flooding the system with money. This is very different than those things. Here we have a lot of things at play; the market’s somewhat confused, and the average investor, whether it’s a professional or retail investor, is confused. Because you have, obviously, Russia and Ukraine, you have what it’s doing to energy prices and the supply chain. You have lockdowns reoccurring throughout parts of the world that are very important for production. You still have extremely low unemployment and significant inflation, causing the Fed to increase rates, so you just have a lot of different factors happening all at once that are contributing to a lot of uncertainty around where the market’s going.
But those four previous bear markets we talked about, we had one thing in common, which is one single event, but also the Fed was helping dig out of it. The Fed was lowering rates and putting money in the system. Here we have a whole bunch of events, the Fed is concerned about a runaway economy, unemployment’s heading too low, inflation’s heading too high. So they’re actually working against the markets in a way by raising rates, and so this is so different than everything else. And the market’s confused and we see this struggle with bear market territory, where we just barely touched being down 20%, now we’ve recovered a bit.
It’s impossible to tell if it’s over, because the reason we’re seeing this volatility and uncertainty for the market is there’s just so many variables at play here; on the one hand you could say, “Well, we’re mostly out of COVID,” or you could say, “But China’s still having lockdowns that affect the supply chain.” You could say, “Look, Ukraine and Russia seems contained and it seems like we know what the outcome will be,” but we know from history that anything can happen. And we could even look at the Fed and say, “Well, this is different, they’re raising rates, don’t fight the Fed,” but they’re raising rates because the economy is too strong.
So I think, until we start to get clarity around some of these issues, we’re going to see more volatility, which tells me maybe the worst isn’t over, but it’s impossible to predict. I certainly think anyone that has any conviction at all around which way the market’s going in the short run is telling you all you need to know about their investing acumen, because nobody should be making very short-term decisions based on what’s going on today; there’s just too many variables at play.
Jonathan: One thing that we can be sure of is by the time we do have clarity about inflation and clarity about what the Fed is up to and clarity about what’s going on in Ukraine, the market’s going to be up 20%, 30% from current levels. You can’t wait for clarity in order to put your money to work, because by then it’ll be way too late. And so, even amidst all this Sturm und Drang in the market, the one thing we know is that valuations are looking better.
I mean, the stock market’s price/earnings ratio has come down as share prices have fallen and as corporate earnings have continued to climb. Meanwhile, the 10-year Treasury note is now yielding almost double what it was at the beginning of the year. So, Peter, I mean, for those people who are sitting at home with a lot of cash, I mean, is it safe to go back into the water? I mean, and if they are going to get back into the water, should they be putting all their money in right away, or should they be spooning it into the market over a few months? What advice would you offer?
Peter: So I’m never a believer in cash, and I think that the way to look at every dollar bill is: assume it’s going to work every day for somebody. So if you just have it sitting in the bank, it’s going to work for the bank; if it’s sitting in your account, the custodian’s making money from it; let that dollar work for you. That doesn’t mean everything you buy, whether it’s a loan like a bond or real estate property or stocks, is going to go up every day, but it is going to produce income for you and, over the long run, it should go up if you’re just a reasonably good diversified investor.
Now, regardless of where the markets are, the data tell us that it’s better to go all in; that if you go all in with your investments, no cash, no dollar-cost averaging, just boom, right in the market, the odds are about 67% that you wind up ahead over somebody who dollar cost averages, meaning you put your money in the market over a few weeks or months or years. Now, we still advise some clients, we talk through both of these with them, and we still advise some people to dollar cost average because of this incredible emotion called regret. People don’t like to go into the market all at once and then things go sideways for them and they can get pretty upset about it and regretful about it, and we know from a lot of research that people suffer losses twice as much as they celebrate gains. So from a psychological standpoint, for some people it’s better to dollar cost average; I’m personally, and whenever I get a paycheck, it just goes straight in the market, right? Always has.
And that’s what I always advise my clients that kind of have abs of steel and can get through anything. And really, even if you go in and the market goes down, it’s still a tremendous art, you’re still collecting income and it’s an opportunity to place tax trades and things like that if it makes sense, if it’s a taxable account. So I’m a big, big believer in all at once, because I follow the data, but we’re all human, humans have emotions. For that group of people that’s worried about regret, dollar-cost average and don’t worry about it.
Jonathan: And, of course, one sort of qualifier we should probably throw in here is: there’s a big difference between throwing in your paycheck into the market and throwing in the huge inheritance that’s life-changing to you and that you’re going to rely on for retirement. So, I mean, if it is a huge sum of money, then maybe hedging your bets a little bit doesn’t seem like such an unreasonable thing to do. That said, given that the market has already fallen, given that valuations are better, I would certainly be inclined to put the money to work faster than I would have, say, four or five months ago. So if, talking of putting money to work, you told me, Peter, that Creative recently rebalanced clients’ portfolios. Some people rebalance every year, they rebalance every quarter, but, from what I gather, Creative follows a slightly different approach to rebalancing, so what is that, Peter?
Peter: Right, I mean, there’s some people that never rebalance, then you wind up with a portfolio completely misaligned with your goals. Some do it periodically, so every quarter or every year. I think you miss a lot of opportunities then, like if you look at the pandemic, the bottom was in March; if you look at the ’08/’09 crisis, the bottom was March 9. If you waited till the end of the quarter, most of the gains had been erased in both of those instances by the end of the quarter, so periodic rebalancing wound up adding no value. We used what’s called opportunistic rebalancing; when an opportunity arises for a specific client at a specific time, that’s when we’re going to place the trade, and it allows you to sell an asset class that’s doing better and buying one that you believe in that is doing worse, and you accelerate your break even date, and so that’s something we’ve been doing through this mini bear market and I think we’ll continue to do it if another opportunity presents itself.
Jonathan: So, finally, Peter, we are at our financial wellness tip of the month. So what have you got us for this month?
Peter: So, okay, most people in 401(k) plans, they invest in target-date funds, which, if you’re going to retire in five years, you might have a target-date 2027 fund, and the fund will have an allocation, mainly between stocks and bonds, tied your age. Most of these allocations are overly conservative, meaning that they just have way too many bonds for your age. I would encourage you, if you have a target-date fund in the plan, if you don’t want to create your own portfolio with what’s in the plan or you don’t have an option to have your money managed based on your risk profile, don’t choose the target-date fund tied to your age. Maybe at least look at the funds that have higher exposure to stocks, because, even if you’re approaching retirement, you have a very, very long, multi-decade time horizon, and we’ve got to fight off inflation, having too much in bonds is going to be counterproductive.
Jonathan: And so an additional comment on that, Peter, is: a lot of these target-date funds continue to become more conservative even after you’ve reached the target-date. So, for instance, the Vanguard Target Retirement Funds, at retirement, the retirement age, they’re at 50% stocks, but then they continue to decline, so within 10 years or so they’re at 30% stocks. Certainly for my taste, that’s way too conservative, and I think probably for a lot of people who listen to this podcast, being only a decade into retirement with potentially a couple of decades ahead of you and sitting with just 30% in stocks, in an environment where inflation could do a lot of damage, that doesn’t seem like a prudent position to be in. So I think you’re absolutely right; I think buying one of those target-date funds that is riskier than your age suggests can actually be a smart thing to do.
Anyway, meanwhile, my financial wellness tip of the month: we all sign up for these subscription services; it might be for streaming channels, it might be magazines, it might be to go to the gym, whatever it is, we sign up for a whole host of these things. And companies love it, they love the fact that they can just go into our credit card accounts or go into our checking accounts and pull out this money every month, because inertia works against us as consumers and in their favor as companies. So what I would encourage people to do is go back over your last three or four months of credit card statements, look back through your checking account, look at those things that you’re paying on an automatic basis and ask yourself, “am I still using these things?” And if not, go ahead and cancel.
So that’s it for this month, Peter. This is Jonathan Clements, Director of Financial Education for 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 results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable, but is not guaranteed.