Following the post-COVID stimulus hangover in 2022, the bull market has continued to run. One of the key factors was the Federal Reserve’s decision to
Knocked Down but Not Knocked Out
Published Date : October 30, 2015
“Everyone has a plan until they get punched in the face.” – Mike Tyson
If the markets were a boxing match, then last quarter’s pummeling would have been met with calls for the referee to intervene. Volatile commodity prices, a potential Greek default, uncertainty around tighter U.S. monetary policy, pharmaceutical and biotechnology pricing worries, geopolitical concerns, an auto manufacturer lying about emission standards, and most prominently, and elevated concerns around the health of China’s economy, have all made this year an exhausting fight for long-term investors.
While conditions can always deteriorate further, and unequivocally bad news is always bad news, the markets have proven remarkably resilient in the face of these mounting concerns. We suspect the reason for this resiliency is that the markets are sensing something far more mundane than these visceral headlines of the moment – that while there might not be a lot to celebrate in the economic picture lately, things are not as bad as they seem.
At the heart of all the uncertainty last quarter was China’s slowing growth rate. Given that country’s general lack of economic transparency – as well as its rapidly evolving economy – the headlines painted a cloudy picture. In fact, the world’s second largest economy has been slowing for years, but investors started to pay more attention to this transition after last year’s fall-off in commodity prices and this year’s mainland Chinese stock market swoon. As a reminder, the Chinese government has been orchestrating a significant rebalancing of their economy for quite some time, away from an economy largely dependent on building roads and bridges to one driven by consumers. The result has been slowing infrastructure spending and slowing aggregate growth.
Our own view is that the market is emphasizing the wrong metrics and instead should be focusing on the strength of the Chinese consumer, given that the majority of incremental economic growth is now being driven by the services side of its economy. Specifically, we are encouraged by the recent results on retail sales and personal income, as well as the stabilization in property prices and improved forward-looking survey data. While Chinese growth uncertainty will not fade away anytime soon, the country remains a powerful economic force and a positive driver of global expansion – and possibly the greatest long-term consumption story the world has ever known.
Meanwhile, the developed economies continue to grow at a positive, modest pace. The U.S. job market continues to improve, corporate earnings (outside of the energy and material sectors) remain healthy, and market valuations are reasonable. Furthermore, our developed economic peers in Europe and Japan are actually experiencing accelerating growth, albeit from a low base. This has helped to contribute to an overall global growth rate hovering around 3% this year, close to its long-term average.
Despite these economic realities, there is an ongoing view shared by many that a global recession will unfold in the year ahead. Of course, the recent market pullback fanned these emotional flames, as well as the uncertainty around the prospect of the first Federal Reserve interest rate hike in nearly a decade and a modest slowing of the economy. But how reasonable is this line of thinking? While the future is always unknown, we see this dire probability as highly unlikely for the following reasons:
First, this would be the first bull market in history to end without a single Federal Reserve interest rate tightening. Historically, the Federal Reserve begins raising interest rates in the middle of an economic cycle, when economic growth is solid, corporate earnings are expanding, and the flicker of inflation expectations is just starting to appear. Over the eight interest rate cycles since the mid-1950s, the market has continued to trend positively for the better part of three years after the first rate hike. This time around, given the unprecedented low starting point on rates, and the likely slow path of subsequent rate hikes, we suspect the cycle could extend further than this historical experience suggests.
Second, it’s worth stating that markets typically experience a 10% correction about once a year and that those corrections are normal and healthy for a rising market. It is also true that more significant corrections and new bear markets don’t just materialize out of thin air. They occur because investors anticipate the onset of a recession. While that fear contributed to the emotional response we saw in the third quarter, as we highlight above, the economic storyline is not supportive of that outcome.
Third, the stock market is reasonably valued, right down the middle of the fairway from a historical price to earnings ratio perspective. And of course, relative to the bond market, stocks remain the most attractive house in the financial asset neighborhood. While that is little comfort during a down period, if investors want to generate portfolio returns greater than the current rate of inflation over time, then they need to own some growth assets and hold a balanced allocation to stocks in their portfolio.
Yet the sense more recently has been that perhaps the markets have taken one too many punches this year and as a result, might not want to get back up off the proverbial mat. That perception is exactly how it feels every time the markets correct and portfolios react accordingly. Sticking to your financial plan, particularly when you feel like you’ve taken a punch to the face, is how you proactively manage that feeling and achieve your financial goals over time.
As in many facets in life, there is a tendency among investors to ignore risks for long periods of time only to suddenly focus on them as if nothing else matters. Rounds like this last one remind us to get up, dust ourselves off, and take advantage of the emotional noise of the crowd in the moment. Our approach is to take advantage of times of market distress like the one we just passed through, and maintain a balanced view and commitment when others typically succumb to the repeated headline blows to the head.
After all, investing for the long-term isn’t truly a boxing match. Stocks are not a zero sum game where somebody wins and somebody loses. Rather they represent long-term investments in the worldwide growth of demand, as well as a play on innovation and productivity and the advantage of size and scale, magnified by the power of compounding those returns over time. While the world, as always, isn’t perfect, in our opinion, it is not apt to suffer a major economic downturn any time soon – and as a result, we think this cycle has plenty of fight left in it.
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