— Two key historic characteristics of the stock market: It works to confuse and confound the maximum number of people most of the time while providing excellent long-term returns.
— So-called “hawkish” commentary by the Fed is credited with sending stocks into a tailspin while, strangely enough, buyers showed up for the US Treasury 10-year which’ yield plummeted to a weekly close at 1.44 % down from 1.59 % mid-week.
— Historically inflation adjusted (real) stock performance has far outstripped bond performance. Surprisingly that has not been the case for the past two decades.
— Is the noise and confusion a diversion from something already priced into the market?
Short-term the market is a confusion machine
Trying to make sense of the daily swings and gyrations of the market is an impossible task, made even tougher by the constant chirping of the media. Last week’s market action was no exception.
For starters we all have preconceived notions (bullish or bearish) that determine how we process news developments. My feeling going into the Fed announcement was that the economy is awash in stimulus cash which should continue to percolate through it (via the multiplier effect) bringing us longer-term growth as well as inflation and higher interest rates. The stimulus, because of its size, would not be a ‘one trick pony’, but would continue to benefit us long after the last check was cashed and spent. To this one has to add the positive effect of some sort of infrastructure spend. As a normal consequence of this deficit spending we would get a higher inflation rate and higher interest rates due to that inflation and the removal of emergency measures previously taken to combat disinflation.
I saw the Fed announcement as being pretty innocuous, leading the economy to a more normal interest rate pattern. Certainly it did not seem ‘hawkish’ (a pejorative the media has made good use of the past few days). Come on! A couple of rate increase in 2023 is not what I would call ‘hawkish’.,
The majority of participants, two-legged and electronic, saw things the other way (the glass 2/3 empty). I am confused. Why, if you expect inflation and interest rates to move higher, would you take the yield on the 10-year down 15 basis points (be a buyer)? That treasury would seem the last place you would go for safety. Why on Thursday the 16th would you pour money into big tech if you though inflation and rates were going up? This would certainly put pressure on high multiple stocks. Nonetheless it did not. Of course, on Friday they sold everything. Monday they started to buy it all back again. I am confused.
Long-term the market is a superior wealth creation machine
For this section I will be relying on the academic work of Jeremy Siegel, Russell E. Palmer Professor of Finance at the Wharton School of the University of Pennsylvania. Siegel’s landmark book examines stock returns from the earliest days of our republic, “Stocks For The Long Run,” is in its fifth edition.
— The book covers 212 years of market history (1802-2012). This includes the first siege of the US Capital in 1814, the Civil War, WWI, The Great Depression, WWII and modern day debacles including assassinations (JFK, MLK and RFK), Vietnam, hyper-inflation and interest rates (1975-1983), the bursting of the tech bubble and the “great recession”/ financial crisis (2008-2009).
–According to Siegel’s work the “average real (adjusted for inflation) return on a broadly diversified portfolio of stocks has averaged 6.6%.
— during the same 210 years the average real return on long-term government bonds was 3.6%.
— Bringing up the rear on this study of returns were short-term bonds (2.7%), Gold (0.7%) and the dollar which lost 1.7% a year versus inflation.
Those who are able to think longer-term and filter out the interminable, inane noise may find the market a excellent place to hold a portion of their assets.
Finally, how many times has the market freaked out over the prospects of higher rates in the past decade? Is it possible that a return to a normal/non-emergency rate structure may be already priced into the market, regardless of what you are getting from the pundits and the media?