SUMMARY:
The stock market is still struggling to get back to the pre-crash highs of early 2022.
But we are still sitting well above the lows reached in October of 2022.
Price trends since August have been negative.
Small cap stocks have not rebounded as much and are still well below their all-time highs.
The major stories are still the same – interest rates, inflation, and recession concerns.
The trend in interest rates and the fact that stocks are approaching a key resistance level (all-time highs) means that we can expect a lot more volatility in the markets in the short term.
The market rally of 2023 has stalled out since the beginning of August. As of the market close on Friday October 13th, the S&P 500 is down about 9% from its previous peak at the start of the 2022. The Nasdaq is down about 15% from its all-time high and the Russell 2000 is still down around 30%. In the graph below, you can see the nice bounce off the October 2022 lows. Stubbornly high interest rates, global economic concerns and the market digesting the big run-up since late 2022 have us in a bit of a holding pattern right now.
The Nasdaq and the S&P 500 have climbed 21% from the lows in October of last year. The Russell 2000 (small and mid-cap stocks) has only gained about 2% since October. This is more evidence of why you don’t want to own small-cap and mid-cap funds. They underperform the large cap index funds over longer time periods, and they get hit just as hard if not harder in bear markets. Advisors recommend small and mid-cap stocks for diversification, but this strategy doesn’t work.
This bear market has been driven by inflationary pressures and its resultant impact on interest rates. While the Fed seems to be nearing the end of its rate raising cycle, the debt markets are still struggling.
When we look at the recent trends in the Nasdaq and the S&P 500, prices have been moving down since the beginning of August. We are watching this trend carefully and will keep you updated on how to position your investments via our Market Signals newsletter.
We remain in a period of volatility and instability in most financial markets. We expect this to continue in the near term.
The reality is that no one knows if the worst is over or not. Because of the uncertainty, it is important to follow a disciplined approach to investing. Followers of our Market Signals newsletter are positioned to benefit if the market keeps moving higher and will be able to limit losses if the market turns down from here. It is critical to have an investing strategy that wins no matter which way the market moves. No one can predict which way things will move in the short term. But we all know that in the long term, the direction of the stock market will be higher. Stay disciplined, my friends.
Happy Investing,
Phil
Disclaimers *The Beyond Buy & Hold newsletter is published and provided for informational and entertainment purposes only. We are not advising, and will not advise you personally, concerning the nature, potential, value, or suitability of any particular security, portfolio of securities, transaction, investment strategy or other matter. Beyond Buy & Hold recommends you consult a licensed or registered professional before making any investment decision.
Investing in the financial products discussed in the Newsletter involves risk. Trading in such securities can result in immediate and substantial losses of the capital invested. Past performance is not necessarily indicative of future results. Actual results will vary widely given a variety of factors such as experience, skill, risk mitigation practices, and market dynamics.
Updated: Oct 22, 2024
If all 401(k) investors simply followed the advice of the financial services industry and invested in target date funds, they would earn about 7.0% per year in investment returns. But because most people are confused and fearful about investing, the average worker only earns between 4% and 5% per year. The confusion and fear cause people to invest too conservatively. They don’t invest enough in the stock market, and they invest too much in bonds and guaranteed income funds.
If 401(k) investors put 100% of their money in an S&P 500 index fund, they can expect to earn 9% per year (including dividends) over their working life. And if they follow our Beyond Buy & Hold system, they can expect to earn 12.7% per year in their 401(k).
These differences in investment returns might seem small. But because of the compounding power of these returns over a 40-year working life, the impact on a retirement account is huge.
Here’s a comparison of the value of a 401(k) for the same person earning different investment returns. This person starts contributing to a 401(k) at 26 years of age and makes the same contributions over 40 years. The only difference is the average annual investment returns.
Based on average returns for actual 401(k) investors (5% per year), this 26-year-old is going to end up with only $643,000 in his or her 401(k) account upon reaching age 65. Yet the very same contributions could result in over $4.3 million with a better investing strategy.
Many workers do a good job contributing to a 401(k) but lose millions of dollars by making poor investment decisions. There are many reasons for this.
Complexity
The financial services industry has created lots of confusing and complex investment products that they insist we all should purchase. They’ve also created all manner of fancy investing terms to make it sound like they know what they’re doing. Are they creating all these products and fancy terms to help investors—or to make more money? You probably know the answer to that question.
This complexity is good for the financial services industry business model. If it were simple, we probably wouldn’t need their products and services. They want us to be confused.
Emotions and Beliefs
Most of what we learned at very young ages about money and investing tends to cloud our judgement today. As a child, I heard lots of stories about relatives who either made a fortune investing in the stock market or lost it all in the stock market (or both).
As adults, we hear about people making millions by getting in early on Apple or Amazon or some other successful company. We hear about people making lots of money day trading—and then we stop hearing about people making lots of money day trading. All of these experiences leave us caught between the competing emotions of greed and fear. And that leads to bad investment decisions. Good investing is disciplined investing, not emotional investing.
Lack of Training
I received a degree in economics from an excellent university. So I understood income statements and balance sheets and important financial statistics at an early age. Yet it still took me decades to figure out the right way to invest.
Much of the training and education about investing has been influenced by the financial services industry and is simply not accurate. It’s tough to learn when even the “experts” are often wrong.
Your confusion and uncertainty about investing is not your fault. The 401(k) is a terrific investment vehicle, but we’ve asked the 60 million people who own a 401(k) to manage their own investments without proper training, and amidst the confusion and noise of the financial services industry. Is it surprising, then, that people struggle with their 401(k) investment decisions?
It is my mission to educate investor like you the right way. And it is not that difficult. We focus on the few key principles that you need to understand and we avoid all of the other nonsense. Follow along with the blog posts like this one and read my books and you will become a confident investor in no time.
Stay Disciplined My Friends,
Phil
Disclaimers The Beyond Buy & Hold newsletter is published and provided for informational and entertainment purposes only. We are not advising, and will not advise you personally, concerning the nature, potential, value, or suitability of any particular security, portfolio of securities, transaction, investment strategy or other matter. Beyond Buy & Hold recommends you consult a licensed or registered professional before making any investment decision.
Investing in the financial products discussed in the Newsletter involves risk. Trading in such securities can result in immediate and substantial losses of the capital invested. Past performance is not necessarily indicative of future results. Actual results will vary widely given a variety of factors such as experience, skill, risk mitigation practices, and market dynamics.
The past two years have been dominated by discussions about interest rates and inflation. Since most people are not economists, I thought I would try to shed a little light on why these topics are so important for your investments.
Inflation's Impact on Interest Rates
When inflation spikes like it did in 2022, interest rates would typically increase so that lenders can get a rate of return on their money that exceeds inflation. In addition, the Federal Reserve raises interest rates to attempt to slow down economic activity. The Fed is hoping that the slowdown in economic activity (demand) will stop prices from rising. Their strategy seems to be working so far in 2023 as the rate of inflation has declined significantly.
But the Federal Reserve has stated that they will not begin to decrease interest rates until the rate of inflation drops to their target rate of 2%. Currently, inflation is around 4%. The Fed has indicated that they will be maintaining their high interest rates until the end of next year.
As a result, investors are not expecting interest rates to change much over the next 12 months or until the Fed starts lowering rates.
Interest Rates and the Stock Market
Interest rates have a pretty significant impact on the stock market. Changes in interest rates often lead to changes in stock prices particularly when interest rates increase.
Let’s look at why that happens.
One reason for this is the competition among investment assets. With only so many investment dollars to go around, money invested in bonds (interest bearing assets) represents money that is not invested in stocks. When interest rates on bonds increase, they become more attractive investments than stocks. When funds move from the stock market to the bond market, stock prices tend to decrease. This is exactly what happened in 2022.
The same thing happens in reverse. If interest rates on bonds are very low, investors are drawn to the potential for higher returns in stocks. Many people think that the rapid rise in stock prices between 2010 and 2021 was partially driven by the extremely low interest rates during that time. In the previous decade, interest rates were often close to zero. Investors were almost forced into owning stocks as bonds became much less attractive.
In the 1970s, inflation and interest rates were at extremely high levels. Bonds were earning as much as 15% per year and people were taking on mortgages with interest rates in the mid-teens. Money moved out of the stock market and into the bond market in the 1970s. As a result, the stock market dropped significantly in the mid 1970s.
There is another important reason why interest rates affect stock prices. Unfortunately, it is a little complex to describe. Investors value stocks based on the projected cash flows of the businesses they represent. Future cash flows are discounted based on current long term interest rates. When interest rates are higher, the future cash flows are discounted more. Therefore, when interest rates rise, the financial value of every company’s cash flow decreases. Stock prices decline as a result.
Since technology and high growth companies have higher projected future cash flows, their stocks decrease more than other companies when interest rates increase. This is why the Nasdaq and technology stocks lost more value in 2022 compared to the S&P 500. The Nasdaq dropped 30% in 2022 while the S&P 500 dropped by 20%.
Both the S&P and the Nasdaq have rebounded nicely in 2023 even though interest rates have not decreased this year. Investors are anticipating that interest rates will be decreasing, however, and that has led to the increase in stock prices this year. Inflation has decreased significantly and that has created the expectation that interest rates will drop in the future.
CONCLUSION
The main thing you need to know from all of this is that rising interest rates are bad for stock prices and declining interest rates are generally positive for stock prices. You also need to be aware that higher growth technology stocks are more affected than slower growing stocks. The financial and economic news can be confusing, but it really is that simple as far as interest rates and stock prices are concerned.
Happy Investing,
Phil
Disclaimers The Beyond Buy & Hold newsletter is published and provided for informational and entertainment purposes only. We are not advising, and will not advise you personally, concerning the nature, potential, value, or suitability of any particular security, portfolio of securities, transaction, investment strategy or other matter. Beyond Buy & Hold recommends you consult a licensed or registered professional before making any investment decision.
Investing in the financial products discussed in the Newsletter involves risk. Trading in such securities can result in immediate and substantial losses of the capital invested. Past performance is not necessarily indicative of future results. Actual results will vary widely given a variety of factors such as experience, skill, risk mitigation practices, and market dynamics.
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