How to respond to the calm of summer
By Kyle Tetting
While summer tends to be slow for stocks in general, this one seems especially so. Part of the explanation could be recency bias. The summer of 2022 may have conditioned investors to expect more volatility. Absent the shocking inflation numbers of last June, it’s difficult to match the market movements we saw a year ago. But it’s also clear that the economic landscape now appears much less uncertain.
Of course, as I write this, the Federal Reserve has recently decided to raise the overnight lending rate another quarter point. At the same time, the S&P 500 continues in earnest an earnings season that seems destined to produce a third consecutive quarter of year-over-year decline. While none of this screams market rout, I would have expected at least a little spike in volatility.
What seems different about the current environment is just how well expectations have been managed. The Federal Reserve had been clear that the rate increase was on tap. The earnings outlook turned cloudy a year ago, and investor sentiment reflected the pessimism. In short, the lack of surprise allowed the sweetening of a stock market that was decidedly sour just a few quarters ago.
What’s left is a market that’s been allowed to melt higher, not because of optimism but from a slow and steady erosion of uncertainty. Down days in the stock market have been few and far between. Late in July, the Dow Jones Industrial Average was challenging the longest daily winning streak in at least 100 years. At the heart of this are two undeniable challenges for investors.
First, investors can’t wait for the all-clear. Stock prices are a forward-looking indicator, and even when expectations are muted, sometimes simply reducing the likelihood of a huge risk is enough to push prices higher. As a result, missing a few short weeks, or sometimes days, is enough to miss out on a meaningful run. It’s why we stress a balanced approach that gives us the confidence to stick to the plan rather than trying to time when we will feel better about investing.
Second, but related, is that our expectations for the future and our perceptions of risk are probably misplaced when tied to the size of our portfolio. Seeing declines in our portfolio can often serve to reinforce concerns, just like market gains may have the unintended consequence of taking our eyes off the risks.
At a time when market performance has been strong and expectations remain steady, I’d argue the pendulum has started to swing back toward vigilance on risk. When we all share the same set of expectations for slow and steady, the consequences of being caught by surprise tend to rise up.
Fortunately, the Federal Reserve has provided alternatives to risk. The inflation-fighting tool of higher interest rates has created a scenario where investors can emphasize bonds. That’s a difficult conversation, considering last year’s poor returns, but it’s one that’s possible because of 2022, not despite it.
So far, it has been a slow — but profitable — summer for investors. Along with profitability comes the opportunity to reassess risk and ensure that we remain comfortable with our current allocations. Stocks will continue to play their part, but I remain pleased that our alternatives now look far more attractive.
Halfway through 2023, outlook improving, by Kyle Tetting
Investor upsides as interest rates rise, a Money Talk Video with Kendall Bauer and Kyle Tetting
What to make of earnings season, a Money Talk Video with Dave Sandstrom
(initially posted July 28, 2023)
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