Whether you are one to scroll the daily news feed or not, it seems an opportune time to offer an additional perspective on current economic events. In a year with little good news, sometimes lighting the path forward can help.
I’ve included a recent writing by J.P. Morgan’s Chief Economist, David Kelly and a Bloomberg graph on the historical average length of the last nine significant market selloffs.
For many investors, there is, of course, plenty of pain embedded in today’s cheaper valuations. However, bull markets always start in the basement of investor despair.
There are plenty of things that could go wrong in the next year. However, there are also plenty of things that could go right. Long-term investors should pay ever closer attention to how these choices have impacted asset prices.
• At the end of last year, the 10-year Treasury bond was yielding just 1.52%, offering investors neither income nor any real protection in the event of a stock market selloff. Today, with a yield of 3.68%, it offers both. Moreover, across fixed-income markets, investors can find much better opportunities with TIP yields turning positive and yields more than doubling since the start of the year across investment-grade corporate bonds, high-yield bonds, municipals and mortgage-backed securities.
• At the end of last year, the forward P/E ratio on the S&P500 was 20.9 times, 24% above its 25-year average of 16.9 times. As of Friday, it was at 15.6 times, 8% below that long-term average. Moreover, within equities, non-mega cap stocks and value stocks are at a steeper discount to their long-term averages.
• At the end of last year, the forward P/E ratio on the MSCI-ACWI ex U.S. was 14.3 times. Today it is 10.9 times. This valuation is not only low in absolute terms but is also very low relative to U.S. equities. It should also be seen in the context of a dollar exchange rate which has risen by an extraordinary 17.8% so far this year to its highest level in real terms since the mid-1980s.
If, over the next year, China transitions to a post-Covid economy, some ceasefire or settlement is reached in Ukraine and the Fed pivots to a less hawkish stance, financial markets could be expected to react positively. Bonds bought today could benefit from lower Treasury rates and tighter credit spreads. U.S. equities could rebound as uncertainty diminished and the economy transitioned to a slow-growth, low-inflation environment. And investments in international equities could benefit from both better local currency returns and a retreat in the dollar from its current super-high levels.
Some of these events could, of course, take longer to play out and the global economy will undoubtedly face new challenges. However, perhaps the most important thing for investors to consider at the start of the fourth quarter is that, while at the start of the year most major asset classes were priced for perfection, today many have been discounted for disaster.
As any shopper knows, it is better to buy low.
A question that gets asked is, how long is this downturn going to last? Here is some historical data on the last nine equity market selloffs:
Over the past 60 years, the S&P 500 Index has experienced nine major selloffs (defined as a selloff of 20% or more), with six of those selloffs exceeding 30%, three exceeding 40% and one, the global financial crisis (GFC) exceeding 50%. The average length of a major equity selloff can vary.
We can’t know exactly what the future is going to bring, so that should not be our goal. It's to understand the risk-reward profile of different strategies and to identify the best opportunity.
While we may know intellectually that the markets will sell off at times, it still doesn’t mean it is emotionally easy, especially when one is in retirement. I always encourage discussion if there is any question on your specific planning.
The market indexes discussed are unmanaged and generally considered representative of their respective markets. Individuals cannot directly invest in unmanaged indexes. Past performance does not guarantee future results. The return and principal value of investments will fluctuate as market conditions change. When sold, investments may be worth more or less than their original cost.