June has just ended and wanted address the most often questions I’ve received the past few weeks/months.  So far this year, the S&P and Nasdaq are down ~-20% and ~-30% respectively and a lot of folks are concerned with (1) the direction of their portfolios, (2) what will the Fed do with rates and (3) what will happen with inflation.  


Q: Have we hit the lows in the stock market?

A: I believe we should be prepared that we have not hit the lows during this bear market.  That said I don’t believe most investors should do anything differently and should stay invested.  We cannot predict what’s going to happen in the markets over the next 6 months but over the long term we do have better insights.  The market, while volatile and unpredictable in the short term at times, consistently goes up in the intermediate to longer term.  In fact, it’s difficult to find rolling 10-year periods of time where the S&P didn’t produce a positive return.  But it does happen and coincides with bear markets (the Great Depression and the Financial Crisis to be specific).

Charts like this have been sent to me as of late but I believe it implies the wrong message (or people read the incorrect one).

This chart shows 10 year rolling returns for the S&P going back to 1909.  The pattern looks very clear at first glance.  The chart shows the most currently period at or near a peak, indicating 10 year rolling returns are likely to decline which would suggest you should decrease your expected return on investment in stocks.  In hindsight, this decline started about 6 months ago. Timing the market is seldom a tactic that’s done with precision by the overwhelming majority of investment professionals…  I digress and back to the point):  the 08/09 period wiped out the return of the prior 10 years (temporarily) but following that decline the following 10 years were extraordinary.  The same can be said of various times when the stock market declined materially.  Meaning, you want to be invested following a significant decline since future returns have been higher during those time periods.

To reiterate a prior point, the market can decline further and even double its recent decline.  However, the future returns for the following 5-10 years tend to be incredibly strong when looking at historical datasets.  

Q: Should we sell and raise cash if we think the market might keep going down?

A: In short no.  We don’t know exactly what’s going to happen and even though you might believe markets will decline further, there’s no guarantee they will.  Using history as a guide, selling after a large market decline tends to produce poorer results over the long term.  I also believe even our most aggressive client portfolios are well-diversified with exposure to various asset classes and global equities.  

Q: If I have cash that was earmarked to be invested should I still invest?

A: Long term, significant market declines present a buying opportunity.  Whether to invest depends on your individual objectives for your investable assets and tolerance for risk.  I don’t suggest you take your emergency cash reserves and invest them and doesn’t mean you should go all in.  If you have cash that was earmarked to be invested, dollar cost averaging over several months or longer likely makes the most sense.  That way, if markets continue to decline, you’ll be averaging down.

Howard Marks, co-founder at Oaktree, has discussed in various mediums his experience of the 08/09 financial crisis.  There came a point in time that Oaktree just had to start buying even though they didn’t know if the market had bottomed.  But they knew they had to buy.  In fact, Bruce Karsh (another Oaktree co-founder) and Howard would take turns each day playing emotional tandem.  One day Bruce would say they had to keep buying while Howard said maybe they should hold off and vice versa.  Looking back, they both agreed they should have bought more aggressively so this is a great example how difficult it is to buy even for professional investment managers.

That’s how I see things today.  Indices are down 20-30% and some stocks considerably more.  But with markets down as much as they are, I believe it’s a good time to start buying if you have cash available, can withstand potential volatility and have a longer-term objective.  If you’re concerned about being down and having lost some of your wealth, selling at this point is not generally recommended, as long as you can withstand potential short to medium term volatility (see below for more thoughts on this).  

Interest Rates + Inflation

Q: Will interest rates keep going up?  Will the Fed keep raising rates?

A:  I believe the Fed is going to keep raising interest rates until inflation declines materially and/or until they see line of sight to inflation returning to their target of 2%.  

Longer term rates going forward, however, are likely to be less sensitive to increases in the Fed Funds rate in my opinion.  So if the Fed raises rates another 0.75% at the next meeting, I don’t believe you’ll see long term rates move by that same % and it’s possible they decline.  That might sound counterintuitive but long-term rates tend to be priced based on long term nominal growth (nominal GDP).  Raising interest rates tends to cause lower growth so at some point, the interest rate increases will hurt growth leading to lower long term rates.  

The market is pricing in another potential 0.75% increase at the next meeting and potential further increases before 2022 is over.  The Fed rhetoric isn’t going to change until CPI starts to decline and I believe that is what the “market” wants to hear.  I don’t foresee that happening for a few months at least barring a steep decline in markets which could cause them to change their views.

Q: Don’t higher interest rates mean stock valuations should decline?

A: Generally speaking, this is true, however, even if the Fed funds rate is 3%, that’s still incredibly low by historical standards.  So while it might portend lower valuations, I don’t believe we will see a market crash based solely on the fact that interest rates increase to 3%.

Q: What will happen to real estate?

A:  Over the past 22 years real estate has behaved like equities.  Low interest rates have led to higher values while rising rates leads to the opposite.  Meaning as interest rates have risen and mortgage rates are hitting 6%, that’s affecting people’s ability to afford homes at these values.  Mortgage payments based on the median asking price of a home has risen from below $1,500 BOY 2020 to $2,514 today, which is substantial. 

As a result, the percent of homes for sale with price drops has increased materially.  Even in Austin which has been booming, prices are starting to soften, and inventory has increased.

Q: Should we hold cash if inflation is high?  Doesn’t that mean we are guaranteed to lose money?

A:  I do believe holding some cash is prudent, but it’s highly specific for each client.  I have some clients who have come into cash recently and my perspective for how they deploy that cash is different vs. clients who hold 5-7% cash in their investment accounts as per our models.  Cash is a position and while over a long period of time holding a lot of cash isn’t prudent, holding cash at designated times is.  And there’s a hidden return to holding cash, especially if it allows you to hold onto your positions and not emotionally sell.

Q: Where do you see inflation going and is it transitory?

A: One reason today’s inflation has us all so concerned is we went a long time without much. That wasn’t always the case.  In the 1990s, a 3% annual CPI reading was common and even approached 5% in 2005. But from 2012 until last year, 3% was a hard ceiling to the point where the Fed was worried more about generating inflation than preventing it.

Based on various reports, inflation is expected to decline towards year end.  The term I would use is disinflation which means falling inflation but it’s still likely to be elevated well above levels we are used to.  The estimates seem to show us ending the year in the 5-6% CPI range.  Long term I believe it’s difficult to forecast how fast inflation may fall or rise.  The term “stagflation” is being uttered more often which means a period of time when growth is slow, but inflation is high.  I believe this term is an accurate description of the current environment.  

Given our inability to forecast high inflation and equity market prices with exact precision (side bar: I don’t know any major investment firm that thought 2022 would be marred by falling stock prices, a likely recession and high inflation), the best course of action is a diversified portfolio. 

Best Regards,

Jared Toren
CEO & Founder

Most Used Sources: Edges & Odds, WSJ Daily Shot, 361 CapitalSteve Blumenthal’s On My Radar

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