Today’s GDP release for the third quarter came in at 33.1%. Not a typo. After the disastrous second-quarter number of -31.4%, the worst quarterly number on record we now got the best quarterly reading on record. What’s going on here? What do I make of that number? Are we out of the woods now? I’m putting on my economist’s hat for today and share my thoughts in a short post. Let’s take a look…
A lot of people – online and offline – have been asking about my opinion on the economy. When will the recession be over? Is the recession over already? How does the recession stack up with other events in the past? What are the risks going forward?
Well, that didn’t take very long! On August 18, the S&P 500 and Price Index finally set a new record high. The Total Return Index (dividends reinvested) had already reached its new all-time-high on August 10. So, we know for sure that this is a new Bull Market and it started after the March 23 Bear Market Low!
May 11, 2020
The stock market is still well below its February all-time-high, but it’s holding up remarkably well considering how poorly the economy is doing right now:
20+ million jobs lost according to the BLS payroll employment data,
30+ million jobs lost according to the sum of weekly unemployment claims since March,
-4.8% GDP growth in the first quarter (annualized rate) and possibly a 10% drop quarter-on-quarter in Q3, which would be reported as a 34% drop annualized!
And a whole host of other economic indicators that look so bad, you’d have to go back to the Great Depression to find similar readings
Actually, “holding up” is a bit of an understatement when you look at the stock market as of the Friday, May 8 close:
The S&P 500 TR index rallied 31% since the March 23 low!
We’ve recovered more than half of the drop peak to trough!
Since April 8, we’re no longer 20% below the recent all-time-high, which is often quoted as the cutoff for the Bear Market!
Does that mean the Bear market is over now? I certainly hope so! Whether the Bear Market is over and a new Bull Market might have started already obviously depends on the definition of Bull vs. Bear. What is that definition of Bull vs. Bear anyway? Different people have different definitions, some more sensible than others. And it gets more complicated: even if we do agree on a sensible definition, there could still be uncertainty over what’s the state of the market right now because some criteria cannot designate the state of the world in real-time but only after the fact. There’s a confirmation lag! So, we could be in a sort of a bull/bear-limbo state right now! How is that possible???
So many questions! Let’s take a look at how I think about Bull vs. Bear…
Wow, I’m in a writing mood these days. A second post this week! Here are a few random thoughts about the current situation. All the things on my mind right now that might be too short to put into a separate blog. Since you’re likely all sitting at home feeling bored, I thought you might enjoy this… Continue reading “Some Random Thoughts on the State of the World”→
“The recession is near!” Headlines like that have become more common recently. And I’m not talking about those ridiculous “sponsored posts” on Yahoo-Finance (“Reclusive millionaire’s warning: get out of cash now”) but the actual news; the Yield Curve inverted recently and then you add the “Trade War” and weakness abroad and everybody gets nervous. Even the U.S. Federal Reserve is nervous enough to start lowering rates again; one cut already in July and another 0.25% cut likely coming tomorrow! So, will the longest-running economic expansion end of “old age” soon and cause a sizable market correction? Or a bear market? Or a market crash? Should we even care? Since lots of readers have asked me to weigh in on those issues I thought this might be a good time to write a post on this.
First of all, hell yes, we should care. If the economy really goes South and the stock market with it, that would be detrimental for retirees and even folks well before retirement. Fortunately, despite all those bad headlines, I’m still sleeping well at night. Sure, the outlook has worsened since earlier this year and I am a bit more worried about the market now compared to before. But I’m still not too concerned in absolute terms. And my view is mostly based on economic fundamentals. Notice how that view is different from some places in the FIRE community where “no worries” has become something of a mantra. The standard applause line there is that “the market always recovers, so we don’t have to worry about a bear market!” But that’s really a strawman argument. Nobody ever argued that we’ll have a recession and a permanent bear market that we’ll never recover from! The stock market is tied to macroeconomic fundamentals and as long as the economy grows we can be confident that the market keeps delivering. But eventually getting back to the old peak is a pretty lame criterion. Why? Let’s look at the chart below from my post earlier this year, but updated to 9/13/2019. It plots the real (inflation-adjusted) total-return performance (dividends reinvested) of the S&P 500 since 2000.
Of course, the market recovers eventually. But it may take a while! The index didn’t reach the 2000 peak until 2013. And a zero-percent real return over 13 years is a pretty lousy goal. Or here is another way to look at the chart: Let’s start at the peak in 2000 and assume the 2001 and 2007-2009 recessions had never happened and the index had instead advanced at 6% per year (even a little bit less than the long-term average). We’d be 50+% richer today. Don’t tell me recessions and bear markets don’t matter! Also, we did catch up to the 2007 peak plus 6% growth, but even that took about 10 years. So, yes absolutely, recessions and bear markets matter because of what they can do to our retirement plans, compliments of Sequence of Return Risk.
Update 8/22/2019: The 10Y-2Y spread inverted very briefly during the day on 8/14, but finished the day at +0.01%. Am I worried now? Certainly more worried than in April when I wrote this piece. The ISM-PMI index is around 51 – that’s also weaker but not weak enough to worry; everything above 50 is still called expansionary, only below 45 it’s a serious warning sign. Unemployment claims are still very low, which is a good sign. So, this is still “only” a mixed bag. Consistent with a false alarm a la 1998. But the probability of worse things to come has certainly gone up!
Well, there you have it: The Yield Curve inverted last month. Finally! Starting on March 22 and throughout much of last week, short-term interest rates (e.g., the 3 months bills) yielded slightly more than the bond market bellwether, the 10-year Treasury bond.
People in finance and economics view this with some concern because history has told us that an inverted yield curve is a pretty reliable recession indicator. And I made this point in my post in February 2018: The yield curve shape, especially the slope between longer-term yields (10 years) and the short end (e.g., 2-year yields) is one of my three favorite macro indicators:
Also notice that I usually look at the 10-year vs. 2-year yield rather than 3-month spread and that made a bit of a difference recently, more on a little bit that later. But in any case, since I went on the record about the importance of the yield curve and now got several reader requests to comment on this issue, here’s an update: in a nutshell, I’m not yet worried and here are eight reasons why…
I started a new series in February on Market Timing Risk Management (part 1 was on macroeconomics) but never got beyond the first part. So, finally, here’s the second installment! Part 2 is about momentum (sometimes called trend-following) and this is a topic requested by many readers in the comments section and via email. Specifically, many readers had read Meb Faber’s working paper on this topic, which by the way is the Number 1 most popular paper on SSRN with 200,000+ downloads. I always responded that read that paper and found it quite intriguing but never followed up with any detailed explanations for why I like this approach. Hence, today’s blog post!
And just for the record, I should repeat what I’ve said before in the first part: I have not suddenly become an equity day-trader. I am (mostly) a passive investor who likes to buy and hold equities. But with my early retirement around the corner and my research on Safe Withdrawal Rates and the menace of “Sequence Risk,” I have that nagging question on my mind: Are the instances where an investor would be better off throwing in the towel and selling equities to hedge against Sequence Risk? At the very least, I’d like to have some rules and necessary conditions that need to be satisfied before I would even consider reducing my equity exposure. I think of this as insurance against overreacting to short-term market volatility!
So, without further ado, here’s my take on the momentum signal…
Last week’s post ended with a bit of a cliff-hanger: I wrote about how the major stock market disasters are highly correlated with U.S. recessions. Since it doesn’t look like we’re anywhere close to a recession let’s not get too worried about the stock market volatility in early February! But I didn’t really elaborate on why I’m not that concerned about the U.S. economy right now. So, today’s post is about what indicators would I look at to reach that conclusion.
The broader context of this post and, hopefully, a few more followup posts in the coming weeks is the question that I’ve been grappling with for a while:
What would it take for me to reduce my equity weight?
You see, a lot of my safe withdrawal rate simulations assume either constant equity weights (e.g. 80/20) or a rising equity glidepath in early retirement (see the SWR series Part 19 and Part 20). But what would entice me to do the opposite? Throw in the towel and reduce my equity share as a Risk Control! Should I ever even consider that?
The broad consensus in the FIRE community seems to be to stoically keep your asset allocation through thick and thin. Physician on FIRE had a brilliant post, adequately titled “Don’t just do something. Stand there!” on why not to react to market swings. That was in 2016 and I very much agreed with that assessment back then. But that doesn’t have to be a universal truth. In my wedding vows, I swore to stay with my wife through “good times and bad.” But the last time I checked I’m not “married” to my equity portfolio, so I should have the right to at least consider scenarios that would convince me to pull the plug on stocks.
If nothing else, thinking about when would be a good time to dump stocks gives me the confidence not to lose my nerves when those conditions are clearly not present, such as during the volatility spike earlier this month. So, what would be the indicators I’m following? Today, Part 1 deals with the macroeconomic picture (but in a future post, I will also share my thoughts on momentum/trend-following etc. as requested by some readers). Among all the different macroeconomic indicators, here are my three favorites… Continue reading “Market Timing and Risk Management, Part 1 – Macroeconomics”→
This is a topic I wanted to cover for quite a while and I think this is the perfect time for it: I got a few posts lined up already dealing with the intersection of macroeconomics and (personal) finance. Of course, I can already hear one objection:
“Oh, come on Big ERN, did you see the volatility in the stock market last week? My portfolio went down by 10+% since the January 26 peak and you want to talk about macroeconomics now? The first week of February 2018 proves that the macroeconomy doesn’t matter for stocks!”
And my response: Yes, this is actually the perfect time to talk about macroeconomics! See, the main reason I was not overly concerned about the market volatility earlier this month is that the economy seems to be running just fine and there don’t seem to be strong signs of any impending recession. Of course, the stock market has some wild swings, sometimes during a recession, sometimes outside of a recession. But all the really bad disasters, the bear markets that sunk retirement dreams in my Safe Withdrawal Rate historical simulations, they all occurred during recessions. And not just any minor garden-variety recession but the big ones! In other words, this is how I insist macroeconomics matters for the stock market:
What do we make of a 10% drop in the stock market? It’s a buying opportunity during an economic expansion! But during a recession, the market might potentially get a lot worse before it gets better!
And in today’s post, I like to provide some empirical evidence for my view…
I don’t think anyone has recommended selling equities and running for the hills. I certainly haven’t, and I am probably one of the more pessimistic FIRE bloggers. Please don’t buy gold coins! Personally, I would never bet against the U.S. stock market. If you had invested $1.00 in large-cap equities in 1871, your investment would have grown to over $13,000 by July 2017, even adjusting for inflation. In nominal terms, to more than $260,000! How amazing is that?
So the good news is: Stocks have the tendency to go up, on average. The broad index not just recovered from every possible disaster we have ever encountered (2 world wars, the Great Depression, several financial crises, the Dot Com bust, 9/11, etc.) but rallied to reach one all-time high after the other. After every cycle of fear, we see a quick recovery back to economic fundamentals. But buried in the equity return chart above is one small piece of bad news; the flipside of the market bouncing back from disasters and returning to the trend is that stocks also underperform after long periods of above-average performance. And this is where Jack Bogle is coming from. He doesn’t forecast a new bear market – nobody can – but simply predicts a decade of underwhelming returns after the strong bull market over the last 8 years. How do you even make a forecast like that? That’s the topic for today’s post…