Hope you had a great holiday weekend.
Ben and I have a lot of Bullets this week. Given the historic first half of the year, there was so much notable (some not so cheery) material to pick from.
- Our primary goal for these Bullets each week is to hopefully provide some curated talking points about the markets, the economy and investment strategies that help in conversations. We also hope to provide some useful resources and a smile or two.
- As always, please let us know if there is something you would like to see or hear.
Last month’s returns were pretty tough, though. No matter if you were looking at value or growth, large cap or small, international or domestic, the stock market lost about 8-9% in June (CNBC, July 2022).
- Emerging markets “only” lost 7% in the aggregate, as the Chinese market was actually higher in June (CNBC, July 2022).
- Diversifiers didn’t help. Bonds lost 2%. Alternatives lost 4%. Commodities lost 11%. Real estate (REITS) lost 7% (CNBC, July 2022).
- The average 30-year fixed mortgage rate, however, only dropped to 5.83% as of July 3 (Bankrate, July 2022). The cycle high of 5.91% was on June 17, 2022. So, let’s see … The 10-year Treasury dropped nearly 0.75% from intra-day high to low over the last few weeks, but 30-year mortgages only dropped 0.08%? (Bankrate, July 2022.)
- The yield to maturity on the Bloomberg Aggregate Bond Index was 3.60% as of July 1. The June 14 high of 4.03%.
- Okay, here’s one rate that has finally jumped up. As of the end of June, the average money market rate is now 1.35%, at least according to Economy.com (other websites are showing lower average rates).
Returns in the second quarter were rough too (using Morningstar indices for equity returns)
- US Market down about 17%; international stocks down 14%
- Growth stocks down about 25%; Value stocks down about 9%
- Bond Agg Index down about 5%; Commodities down about 6%
- US Market down about 21%; international stocks down 19%
- Growth stocks down about 34%; Value stocks down about 7%
- Bond Agg Index down about 10%; Commodities up about 18%
- “If you’re making contributions to a 401(k) or IRA on a periodic basis you can now buy the stock market at prices that are 20-30% lower than they were just 6 months ago.”
- “You can also earn around 3% on intermediate-term U.S. government bonds instead of the 0.4% to 0.9% you could earn just 18 months ago.”
What happens to stocks after a bad first 6 months of the year? There are numerous articles on this topic. Take your pick depending on your mood.
- One hopeful take is comparing this year to 1970, since the first half of 2022 was rivalling the worst for US stocks since 1970. When the S&P 500 plunged 21% in the first half of 1970, it promptly reversed those losses to gain nearly 27% in the second half (CNBC, June 2022).
- However, according to the research firm Strategas, and looking at data since 1950, the odds of a positive return the next 6 months is only 54%, which is well below the average probability of a positive return over the next 6 months. The average return in those years is positive, but also below the long-term average 6-month returns.
- Commodities are still outperforming US stocks: 14% vs 10% (Yahoo! Finance, June 2022)
- US Growth stocks are still outperforming US Value stocks: 9% vs 8% (Yahoo! Finance, June 2022)
- US large caps are still outperforming US small caps: 11% vs 4% (Yahoo! Finance, June 2022)
- US stocks still outperforming non-US stocks: 10% vs 2% (Yahoo! Finance, June 2022)
- Disinflation (i.e., a peak in inflation growth) could trigger a second half rally
- Sustained yield curve inversion would signal a hard landing
- The economy avoiding a recession
- Getting on the other side of the midterm election. Midterm years are typically weak through Q3, on average.
- Avoiding an earnings slowdown
- On that point, in RenMac’s excellent 15-minute-ish podcast each Friday (only 10 minutes if you speed it up fast enough) it was mentioned last Friday to expect gas prices to drop a lot in July.
- By the way, JPMorgan wrote last week regarding oil prices of the worst case scenario: $380/barrel oil.
Bad news on inflation: headline CPI could approach 11% before the end of 2022, delaying “peak inflation” until 2023 (Research Affiliates, June 2022).
In my opinion, “peak inflation” is a big deal. The potential peak in inflation growth could indeed create a tailwind for the markets. Remember that markets don’t trade on whether absolute conditions are good or bad, but rather on whether they are getting better or worse relative to expectations. Looking back, and using some research from Invesco, peak inflation in 1974 and 1980 were times when things were “bad” but soon to get “better”. The economy even entered a recession in mid-1981, but the key to remember is that the stock market generally does well after peak inflation (Wealth Advisor, June 2022).
Let’s talk sentiment. A lot of articles recently on how investors have finally “capitulated”. Last week JPMorgan even wrote that investors bailed ship.
Investor sentiment does indeed remain poor, according to the latest AAII Sentiment (American Association of Individual Investors, July 2022), and that typically means above-average returns 3-, 6- and 12-months from now.
But, I would argue that we haven’t seen capitulation yet, at least not yet looking at average equity allocations according to the AAII Asset Allocation Survey.
- Bottom line, investors are still heavily invested in stocks and near 20-year highs in equity allocations.
- Recent stock holdings of 67.1% compares to 61.6% long-term average since November 1987 (415 months). Median 63.6%.
- Current AAII equity allocation ranks in top 28% of all monthly equity allocations since 1987.
- This number has slowly been coming down since the recent cycle high of 71.4% in November 2021 (top 6% of all historical equity allocations).
- Before the November 2021, the only higher monthly equity allocation over the last 20+ years going back to the beginning of 2000 was one month in 2017 (Dec) with a reading of 72.0%.
While individual investors are bearish on the markets, there is one group still positive from here to year-end. It’s Wall Street! While sentiment on Wall Street isn’t as optimistic as it was earlier in the year, according to work from Aneet Chachra of Janus Henderson (hat tip to John Authers) they are unanimously bullish for the rest of the year. The S&P 500 closed at 3825 on Friday, July 1, 2022. The most negative view is for a 2% price return (not including dividend yield into the total return forecast) and the most optimistic is for a 28% price return.
Speaking of outlooks, Ben and I conducted a poll of the strategists on OPS at the end of June. Here is their outlook on the six major asset classes for the next 6 months.
Orion Portfolio Solutions Strategist Outlook (Next 6 Months)
- Bullish on Real Assets and Absolute Return Alternatives
- Bearish on other asset classes; most negative on US stocks
Some have asked how much should one have in real assets? One frame of reference is by looking at the ETF Industry AUM, per Bernstein. It’s only about 5% as of 14 months ago, but given the strong outperformance of commodities since then, and now the increased investor demand, that number is surely higher.
Those are good frames of references, but how much do influential asset allocators recommend to real assets? First, what about arguably the most famous asset allocator of all, David Swensen (ofdollarsanddata.com, May 2021)? His well-known take on a balanced long-term portfolio for individual investors included a lot of juicy nuggets including 20% in real assets (expressed through REITs), 40% international stocks for equity holdings (with an overweight in EM), and a fixed exposure split evenly between nominal and inflation-linked Treasuries (note zero exposure to credit risk)! (Of course, this was just a baseline portfolio that would need adjusted given an investor’s objectives, risk tolerance, and other unique considerations).
- 30% US equity
- 15% Foreign developed equity
- 5% Emerging market equity
- 20% US real estate (REIT)
- 15% US Treasury Bonds
- 15% US Treasury Inflation-Protected Securities (TIPS)
There are the academic and strategic reasons to invest in real assets. There are some potential tactical reasons, too, besides the inflation argument. There is also the long-term cycle argument. Just Google the phrase “commodities vs stock prices” and you’ll find lots of charts, including a slightly dated one sourced from In Gold We Trust Report and posted @jessefelder on Twitter: “Compared to the S&P 500, the GSCI Commodity Index (TR) is at its lowest level in 50 years. The ratio is currently at 0.48, well below the long- term median of 4.10 and miles below the highs.”
If 50 years of history isn’t enough, there’s 151 years of stocks to commodities posted at Longtermtrends.
Mostly negative data in last week’s economic data (First Trust, June 2022):
- A lot of good news/bad news in the final estimate for 1Q22 Real GDP
- Real GDP growth in first quarter was revised slightly lower to a -1.6% annual rate from a prior estimate and consensus expected -1.5%
- The GDP price index was revised up to an 8.2% annual growth rate from a prior estimate of 8.1%
- Nominal GDP growth – real GDP plus inflation – was revised up to a 6.6% annual rate from a prior estimate of 6.5%
- Good news? First Trust doesn’t think first quarter was an economic contraction as “Real gross domestic income (Real GDI), an alternative measure of economic activity that is just as accurate, was up at a 1.8% rate. The problem with GDI data is that the first report doesn’t arrive until one month after the GDP data, so very few people pay attention. Closing the case against a recession in Q1 is that industrial production and jobs rose rapidly while unemployment fell.”
Friday’s employment data is the highlight on this week's economic schedule.
- The consensus is for 270,000 jobs added, and for the unemployment rate to be unchanged at 3.6% (Calculated Risk, July 2022).
- There were 390,000 jobs added in May, and the unemployment rate was at 3.6% (Calculated Risk, July 2022).
Additional Resources
“There is virtually always an apocalypse du jour going on somewhere in the world. And on rare occasions when there is not, journalism will simply invent one, and present it 24/7 as the incipient end of the world.” Nick Murray
There are 24 charts that show we are mostly living better than our parents. (Full Stack Economics, June 2022).
This week on Orion's The Weighing Machine podcast we hear from an experienced asset allocator and manager-of-managers Josh Emanuel, the CIO at Wilshire Advisors. Wilshire is the longest standing relationship with Orion Portfolio Solutions (and before that FTJ Fund Choice). Josh’s experience and insights are obvious.
Morningstar’s article 5 Things To Do in a Bear Market includes:
- Reviewing savings rate or distribution rate
- Rebalancing
- Consider buying the dip
- Tax loss selling
- Consider ROTH IRA conversions
Normally, I don’t mention new bills or acts that the government is working on, but there are four quick ones that could impact our industry:
- First, last week, the Senate Finance Committee approved the Enhancing American Retirement Now (EARN) Act, which contains some provisions that are included in the House-passed Secure 2.0. EARN would raise the age at which taxpayers must start making withdrawals from their retirement accounts. Raising the age from 72 to 75 allows three extra years of tax-free growth after 2031. EARN would also allow taxpayers who are between 60 and 63 to contribute an extra $10,000 to tax-preferred retirement plans that allow elective deferrals ($5,000 for Simple plans). This amount would be indexed for inflation.
- Second, the SEC requested information and Comment on Advisers Act Regulatory Status of Index Providers, Model Portfolio Providers, and Pricing Services. In short, the SEC believes a lot of index products involve a lot of active decisions.
- Third, and I like the possibility of this one, a new bill would allow rollovers from 529 plans to Roth IRAs (Think Advisor, June 2022).
- For ESG investors, the Supreme Court rejects broad EPA authority to regulate greenhouse gases from power plants concluding that the EPA lacks broad authority to regulate greenhouse gas emissions from power plants under the Clean Air Act (Reason.com, June 2022)
Good Dadding in a June 30 tweet from @derekRadleyGolf incorporating baseball and a fishing pole!
This time of year is awesome with all the fireworks in the air, but a strong seasonal favorite of mine is the awesome “summer snow” from cottonwood trees.
Thanks for reading and have a great week! As always, please let us know what we can do better at rusty@orion.com or ben.vaske@orion.com. Invest well and be well.
1193-OPS-7/8/2022
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