Seeing blue sky through cloudy forecasts
By Kyle Tetting
There’s a tendency in investing to speak about expectations for returns. Projections and forecasts are useful and necessary, especially as we try to plan for the future. However, those same tools are fraught with challenges.
For starters, the crystal ball is always a little cloudy. Especially with the unknown timing and magnitude of the Federal Reserve’s remaining steps to fight inflation, long-term optimism can get overlooked. We factor uncertainty into our allocation, relying on balance and, increasingly, short-term high-quality investments to help us get through to the opportunities beyond the current risk. But then too, we often forget how we got to this point.
Consider that the S&P 500 declined 18.1% in 2022. That’s not news to investors looking at their account statements. What the statement doesn’t show, though, is that the S&P gained 9.4% per year across the five years started in 2018. That gain even includes last year’s decline. In other words, even with a year of meaningful setback, the longer-term track record for stocks remains strong. Looking only at the 3-year, 5-year or 10- year number tells a very different story than any year individually.
So far in 2023, we have seen a microcosm of that lesson. Through the first two months of the year, the S&P 500 advanced 3.7%. But just as longer-term returns aren’t simply a straight line up, 2023 so far has been a tale of two markets.
January’s hot start came on the heels of a half year of declining inflation rates and market hopes that inflation was well on its way to being tempered. Then, strong-enough economic data and a January inflation reading that showed we aren’t yet out of the woods put the market back into a tailspin in February.
That volatility is to be expected. As each new data point tells us a little more about what’s happening, investors respond by determining at what price they’re willing to buy and sell. Each new data point is only one small snapshot in time.
January’s personal consumption expenditure index showed prices increased 5.4% from the year before, a slight uptick from December’s reading. Of course, one month of inflation headed in the wrong direction is concerning, but a single data point is not a trend. Nevertheless, with unemployment remaining a non-issue so far under the Fed’s dual mandate (full employment and price stability), any signs of persistent inflation rile investors’ nerves about the remaining path forward.
Given the constantly clouding crystal, projections and forecasts become even more fraught. Expectations for a modest increase in the S&P in 2023, for example, may not be misplaced. But the index does not go up in a straight line. As a result, our long-term optimism isn’t suggesting that every measurement along the way will always point in a positive direction.
So, with two months of 2023 under our belts, we can be pleased with the strong start to the year and still acknowledge that volatility may persist. The Fed has work to do, other uncertainties remain and investors will continue to adjust how they value their investments in light of new data. With higher interest rates on cash, bonds and other alternatives to stocks, we have a better-than-ever opportunity to persevere through short-term uncertainty, and we needn’t lose focus on why we invest.
Stocks: Long-term, consistent returns, a Money Talk Video with Dave Sandstrom
Investor upsides as interest rates rise, a Money Talk Video with Kendall Bauer
How investors can navigate bear markets, a Money Talk Video with Steve Giles
Rebalancing: More investing, less emotion, a Money Talk Video with Steve Giles
(initially posted March 2, 2023)