After modest losses in the beginning of 2022, stocks entered a bear market in the second quarter with a pullback of more than 20% from the recent highs. Inflation persisted, with the Consumer Price Index hovering at 9.1% in June, even as the Federal Reserve raised the fed funds rate three times in the first half of the year in an attempt to control rising prices. The Fed’s dual mandates are to pursue maximum employment and maintain price stability, which they define as an average of 2% inflation over time. They’ve accomplished half of their goal, with unemployment at a historic low of 3.6% in June, but have major challenges in getting inflation down to 2%. The Fed’s primary tool for fighting inflation (raising interest rates) can only do so much when there are external forces beyond their control like the Russia-Ukraine conflict and China’s COVID shutdowns.
Inflation wasn’t the only issue causing increased volatility. The Russia-Ukraine conflict continued on, keeping oil and food commodity prices at elevated prices. The U.S. saw rising interest rates put a damper on the housing market with existing home sales dropping 20% in June compared to the prior year, according to the National Association of Realtors. In general, central banks and governments across the world became less accommodative in their monetary policies and COVID relief programs.
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Rising prices deeply affects us on a personal level and we may be able to commiserate with friends and family on a local level, but understand that this is a global problem. We’ve all heard of the runaway inflation situations happening in Turkey (78.6% as of June) and Argentina (60.7% as of May), but even developed countries are seeing increased levels. The UK, Canada, and Germany join the U.S. in nearing double-digit inflation as they’re dealing with the same issues: COVID, backed-up supply-chains, loose monetary policies, and high oil prices.
The U.S. labor market has experienced an incredible rebound after the COVID shutdowns in 2020. Unemployment hit a low of 3.6% in May, below its long-term average of 6.2%. This was accompanied by a rising wage growth of 6.5%, well above the long-term average of 4%. Wages were stagnate for nearly a decade after the 2008 financial crisis, but now workers have the advantage over employers when it comes to their pay and work-life balance.
More Reasonable Asset Prices
At face value, declining asset values are worrisome because we can’t determine when they’ve found a bottom. There are many metrics that are used to analyze the stock market, but one of the most widely used is the forward price to earnings ratio. Investors are willing to pay a multiple of a company’s earnings per share. Past earnings are obviously the most accurate because they’ve already been reported, but don’t give an indication of what may come. Forecasted future earnings give us a better sense of the direction a company is heading, but is ultimately just an analyst’s best guess based on publicly available data. The S&P 500’s forward P/E ratio was over 22x last year, more than one standard deviation above the long-term average of 16.85x. By the end of June 2022, that ratio was down to 15.94x, signaling that market is no longer considered overvalued. However, that doesn’t mean stocks will start skyrocketing again soon. Investors just might be more cautious in their buying, rather than senselessly overpaying for stocks. The major differences now is a tightened monetary policy, higher interest rate environment, and slowing global economy.
U.S. housing prices maintained their growth trajectory compared to the stock market, as indicated by the median sales price chart below. Predicting real estate prices can be difficult as it takes into account numerous factors: supply, demand, median incomes, and interest rates. Although higher 30-year fixed mortgage rates have climbed significantly higher this year, buyers have alternatives such as adjustable rates which typically afford them a lower monthly payment. The case against this being another 2008 financial crisis is today’s home owners have higher credit scores because of more stringent lending requirements and the inventory of homes is low due to years of underbuilding after 2008.
Consumer Sentiment & Emotional Investing
The University of Michigan’s Consumer Sentiment Index (CSI) sank to a score of 50 in June, even lower than it reached in the depths of the 2008 Great Recession. High inflation and gas prices really has a tremendous effect on those already marginalized Americans, even if they are fully employed. Although the consumer’s feelings are valid, they may not be the best leading indicator for making investing decisions. In fact, it seems going against consumer sentiment has yielded a better return. In the last fifty years, the S&P 500 performed better on average in the following 12-months after the CSI hit a bottom (+24.9%) than after it peaked (+4.1%). Naturally, people feel confident when things are going well and are anxious when conditions have already deteriorated.
Fear and concerns should be addressed, but should not be a factor in making big investment decisions. Understanding your goals, time horizon, risk tolerance, and total financial picture are what’s necessary to make investing decisions. This is why it’s imperative to review your financial situation at least once a year.