The last time we visited, the S&P 500 (SPY) was around $400 per share. It is currently around $390 per share at the time of writing this article (roughly the same price). As you know, we added to positions during the recent pullback from the 200 day mavg, which we predicted would happen, as the 200 day mavg typically acts as strong resistance to prices when they are below it.
During the brutal process of just watching your money essentially evaporate in front of your eyes every day, it can cause some real soul-searching moments to occur, admittedly. I had to keep asking myself if my thesis was correct, and if my strategy was still the right one as a result. Did I have the right goals in life, etc.
We Remain Positive on Markets
However, I continue to maintain my bullish stance on the markets, as well as my view that passive income investing in the “stock market” is the easiest way to achieve freedom and happiness in life for my family. It helps to have a bull market, but I make the same dividends in a bear market, even more in many cases, because I buy more as share prices fall (even after factoring in dividend cuts).
As long as nothing “BREAKS” in the financial markets, which has now been cleared up by the banks, as seen by their recent earnings announcements this quarter, then crisis averted; and since everything else should be priced in, then keep adding to shares, I tell myself.
Some banks in Europe are having trouble, sure, but they’re issues that are not systemic to the region as a whole, at least from what the market seems to be saying. SPY at around $400 says a lot, as well as the strong earnings we have seen from companies so far this quarter.
So what, MSFT disappointed by a billion or something like that. They still made around $50 billion during the quarter which is insane. As long as growth from the cloud and other segments remain, then EPS will stay strong, boosting the SPY’s EPS estimates.
If every company in the SPY posts similar results of strong but moderating earnings, then EPS will continue to grow or stay steady for the index, while prices drop or remain sideways, which ultimately lowers the P/E multiple. The lower the P/E, the more attractive the price of the index, of course.
If the dollar drops, take currency issues off table. Then factor in other EPS engineering tricks like share buybacks, acquisitions, and dividend raises, and the market P/E can become even more attractive between now and in 2024.
Most Importantly:
Combine positive EPS odds with a dovish Fed from next year on out, and the odds of a strong rally increase dramatically. The funds rate of about 5% is already expected and priced in, so increased hawkishness from this point on seems unlikely as inflation continues to fall.
Remember, the fed funds rate is projected to go below 3% in 2024-2025, as well, and the market is forward looking 12 months. So, we could be at a bottom in all things based on that window of hawkish then dovish rate activity within only another year, and other positive EPS fundamentals listed above.
You may think I’m getting fancy discussing “ratios”, the federal reserve, and P/E multiples. But these have been critical bear pillars used in the construction of their arguments, and they need to be disproven, which I will attempt to do below through a series of email exchanges with my dad.
Email From My Dad:
Todd,
So, I understand your angst – I have the same questions in general about the Fed. A couple of thoughts:
1 They have talked a lot recently about the “terminal” rates of 3.5-4.5%, and the implication has been that they would stop there. However, there is no commitment to stop there, and historically they have gone much higher a couple of times, and a 6-7% rate really impacts a lot, both individually and the economy as a whole.
On my first house I paid approx. 10% interest on the loan. This compares to 5-6% now and 2 ½-3% last year. That makes an incredible difference in monthly mortgage payments and basically killed the housing market for several years. I think they will stop at about 4.5% as long as there are some concrete results in inflation numbers, since they claim to be data-centric.
2 I understand the expression that the market looks ahead one year, and I think that is typically true. However, a strong inflationary spiral can go on for a long time – definitely more than one year – and that makes it very difficult for the market to look ahead for one year with anything but negative thoughts. Maybe that is impacting things right now.
3 That expression “priced in”. I think it applies almost all the time – not a year-ahead priced in necessarily, but short term definitely usually does. That is why I have been so surprised at the reaction of the market. I thought a 75-point increase was priced in for sure, even trending to 100 points. So, I expected the early rally yesterday to continue. I almost told you to put more money in for me.
4 How much of this do you think is caused by algorithm-led computer selling? There may be some kind of “uncertainty factor” built into these algos, sort of like contingency money that is included in any fixed price contracts. If there is a major unidentifiable risk, then issue a sell order.
Altogether my thought is that, if we see a reasonable level of reduction in inflation stats, then I agree with your supposition that there will be one more rate hike, it will last for a year, then it will move back down. That may be the best we can hope for.
Right now my crystal ball was unclear, has moved past hazy, and is now completely opaque and impossible to read.
Sorry I am not more help.
Love,
Dad
My Response:
Dad,
Agree with all points, especially #3, in that things can always change. I get that. Even the Fed admitted yesterday they were wrong about economic projections before. But I think they are, and even said yesterday, that they are getting a better grip on how to project data.
But, to #2 and inflation persisting, I agree with your angst, too. However, if inflation is indeed coming down visibly, to us, and the Fed sees it too, then isn’t that all you need to know, that they aren’t hell bent on ruining us?
But instead, are perhaps just raising rates because they need to. Housing is too expensive. Rates can’t stay at 0 forever. People need more return in cash. Makes markets more stable, too maybe. Maybe it’s all a good thing and necessary, regardless if supply chains and Russia will fix themselves on their own. Shelter prices, again, are too high. There is a housing crisis going on in many parts of the country.
My Angle:
Inflation persisting with slowing tapering prices – is totally different than persistent inflation with high, persistent prices- which would be terrible, I agree.
I’m in the camp of peak inflation, and gradual improvement from here…and so buy now.
Similar to covid, with peak hospitalizations from a certain point, which then the reopening was based on…so too will be interest rates on inflation…and the peaking of it at a certain point. That will make higher highs and lows in the markets, as economy gradually improves in 2023. Fed will be less Hawkish next year (as long as inflation continues to drop).
Again by 2025, they want the terminal rate under 3. That ultimately means easing between now and then.
With covid, I knew just to buy now because it’s all politics, which many people hated, but the reopening was going to happen regardless; and if so, then just buy NOW. Don’t wait for the hospital numbers each quarter. You know we will reopen because life has to go on, and people will choose freedom over tyranny in the end, anyway.
The same reopening schedule applies for now, to me, with inflation and the Fed interest rate hikes being the new schedule to gauge the market by.
People will be contemplating CPI numbers that will likely be bad next month (due to a delay in calculation methods), and saying Fed has to raise more, causing a definite recession. Watch.
When really, it’s just like the covid numbers, in that you know inflation (or hospitalizations) is improving.
If employment is strong. Really strong. And as long as consumers keep spending, then GDP will hold up. They will spend less in certain areas, sure. Like houses and higher priced cars. But continue to spend elsewhere on bills, even low-priced cars, because people really need them right now. For instance, I heard recently that the average age of cars is way too high.
So, that’s good. But there is still work to do to get inflation down further of course; only it’s a gradual step-down process, where analysts estimates will then gradually go up as inflation continues to drop and spending starts to increase again, as prices are too cheap to ignore, AFTER the Fed stays neutral or even cuts at the point of recession in 2023.
Again, that could be early as next year. If market is forward looking (which I know I keep repeating) then estimates would gradually begin to go up from up THERE, so BUY NOW. Buy the rumor, sell the news.
I think that the companies in the S&P and therefore the USA will get through this, as long as inflation has peaked, like with covid numbers. Estimates will come down now for some, like Ford and FedEx, inflation numbers will still be hot (from the delay in CPI calculation method), and interest rates will go up. Oh the horror, as Tony Danza always said. But only for one more month. Then we make it to the famed mid to peak terminal rate area of around 5%. Since the Fed said we are already at the low end NOW, at the mid to high 3% area, then raising another 75 25 and 25 this year and next gets you to the 5% area.
It’s almost perfect timing to buy now, isn’t it?
Conclusion
I know it’s a headache; but figuring out this logic is all that stands in the way of having a clear game plan, and ultimately making a lot of money from capitalizing at these lows in the market. But are these the lows? Inflation will tell us. But, then you have to look past the numbers, ahead 12 months, and see the bright side, and I do. I think everyone else does, too, with the strong of employment and demand numbers still seen in the economy.
So, why not bottom now? At least why sell!? Maybe it’s just algos, like you said. Who knows. I KNOW one thing, that this is all a buying area LONG term; I won’t be wrong on that, since we are still 20% off highs. Going lower from here won’t change that fact. And we will get to old highs again and again and again, one day. Like we always do. If not, there are bigger problems in the world than money at that point, so who cares.
Love,
Todd
Email To My Dad After October Fed Announcement
Dad,
1.) They (the Fed) are not blind and cavalier:
High unemployment. High wages. Strong consumer. And they also acknowledged: weak housing, weak energy, weak fixed income side of corps.
2.) They are not out of touch with public or their own policy:
They also said: their decisions have immediate impact as well as a delayed impact, and they are data dependent each meeting as to the effects of their policy decisions. Not out of touch their either.
3.) They said they are currently at low end of restrictive policy, which is a 3.5-4.5 terminal rate. So we are there, like I said, after one more meeting. Will remain there for one year. Market is forward looking one year. So again, we should be at priced in levels, NOW.
4.) He said economy growth will be .25 this year and 1.25 next year. That’s not a recession!
5.) therefore they have maintained credibility.
All five points are what the pundits have been slamming the entire year. And all 5 were massaged out today. Whatever they say next will be in reference to those 5 points, and what can they say that’s bad about them?
They are all worrisome, but priced in. That’s the question, is this priced in to them? To you, Dad?
And then I would ask, what does this “all being priced in” need to look like? Do investors want a bow tie for their thesis? A perfect world? Bull markets always climb the wall of worry. And all worrisome points here are working themselves out.
Geopolitical risk stepped up today, but that has never swayed markets for long, like all wars. We learn to live w them, assuming no nuclear in which world is over and who cares about money. That’s why Russia is a buying opp…a balk on nuclear. If you think nuclear will happen, we’ll have bigger problems than money.
On the yahoo article: one former fed guy had a higher number. But they use a consensus. The terminal rate could be lower by that same virtue, too.
This will be the game played, I think. Even if 5%, IMO it’s not a big deal bc it’s still not high historically. Growing up in investing courses they always said for bull markets to sustain, interest rates can go to 4-6%, that’s the limit. Same for inflation.
Well that’s what we’ll have next year. So buy now…or at least bears shouldn’t sell anymore bc of this
Email to My Dad on Coping with the Bear Market & Higher Margin Levels
Dad,
To be fair, holdings held up well from the higher premiums seen for months prior to this, and are now just resetting to market prices; no premiums left.
My ego is feeling quite good since I don’t have to prove it to anyone at this time; everyone is in the house of pain together. It’s all about proving to yourself, I know.
But, even proving to myself that I had a certain number, like purchasing power reaching a million, is meaningless when I die, and someone else always has more than me anyways. So, it’s not really an accomplishment, to me, to have a higher net worth then some when it’s all relative. Pure illusion, really. I just need to be able to pay my bills and be free of a 9-5; that’s all I want as an accomplishment; and that outlook helps me deal with market pain better.
But I feel sometimes I have to rework my expectations in life with prospects of a market like this.
…On adding more margin/leverage
I’ve been in more margin before and dealt with the baggage of margin debt. So, I’ll deal with it again. My margin levels are still at substantially lower levels than last year, at least. Plus, to think that I would have been home free, and virtually retire to live happily ever after at 36, would have been too easy, I suppose, and not a worthy of a real success story. This is what I tell myself, at least.
…On the validity of this new rally forming in late October/ early November
Most people are saying this is just another bear market rally. But, the dollar (UUP) just broke the 50 day mavg to the downside recently. COULD be a good sign in that it means a rollover is occurring in the dollar, and therefore the bounce has another few % points up, as stocks are moving inverse to dollar and bond yields.
Who knows, can’t time. The risk of being out of holdings at the bottom is too great, IMO, vs. just going a few points lower in order to get a similar price anyway, when you include DRIPs (dividend reinvestment programs). Afterall, the DRIPs in our holdings usually buy lower for you, better than the market prices can give. No need to time.
& The accepted threshold for premiums on our funds should be rising, along with dividend cut worries not being as bad as feared, as market prices (or the fund’s NAVs) rise to more sustainable levels on hopes of a red wave, better than feared EPS materializing, and a soon dovish fed, to name a few.
Email To Dad Following the November Fed Annuncement
Dad,
So, keyword today in press conference (not in official statement that precedes the conference):
Fed funds rate could be HIGHER than the expected 5-5.5%. Ugggh. He was more hawkish than ever in the conference…. While the press statement was dovish.
He added that keyword in the darn press conference and we tanked. Not cool. He didn’t need to add that word. He said inflation is coming down, but still needs more rate hikes than even before, WHY?
You could argue that some had such a good read on the Fed’s gameplan that the Fed still wanted to “talk down” the markets again, knowing that it was STILL too early to call a bull market, because prices could rise perhaps too quickly in anticipation of the cut, that of which is only 12 months away (and market is forward looking 12 months).
If the Fed didn’t “insert” that key phrase of higher than anticipated, the algos and everyone else including their grandma could have figured out the buy signal of a hawkish then dovish Fed within the next 12 months, hence a market bottom should come now- and the Fed can’t have that while trying to tame inflation.
So, I think they crafted that “new phrase” to throw us another curveball, in order to make the recovery not a layup, so that they keep home prices and other inflationary agitators honest; and then they will still come in lighter than expected in the end to save the day- HOPEFULLY.
Just my guess as to why they would do such a terrible thing to people’s retirement accounts today…in an election year on top of it all. Have they truly lost their minds, or is the Fed just bluffing to keep us all in check? Time will tell.
Update: Market Flirts With 200 Day MAVG
As you can see by the yellow line, every time we get to it, the 200 day mavg, we fail and go much lower. This time I think is different, though. Here’s why:
Well, we have been flirting with breaking above it, as seen by how the S&P has gotten there and is currently resisting it, but this time the S&P hasn’t declined sharply like it has other times in the previous year.
So, I think this time we break above it, or at least not decline as sharply on the fail, as inflation is coming down, prices in the stock market have come down 30%, and earnings are staying resilient.
Historically, this is a great time to buy no matter what the noise, bc we were 30% off highs…
…10%,20%,30% down …all are good areas to buy long term since the S&P makes new highs over time, or gains 7% per year.
Now combine that haughty S&P stat with improving macro from Fed and inflation, and you get a layup buy IMO.
Risks to Thesis:
Did inflation really top? I think it did since Fed remained hawkish, even in the face of improving inflation.
So, the lag in CPI (18 months), should only work in our favor, now that it has caught up to Fed’s speak which started 12 months ago as of today-last November to this November.
The million dollar question to me is, with respect to the 18 months (from cpi)- and 12 months window (when fed began tightening), have the 6 months of delay truly elapsed?
I think it did; we took the 5-6 months of brutal cpi numbers that were clearly lagged, bc March-April is that 6 month timeframe from November, and ever since then inflation has been creeping down, WHILE Fed has REMAINED hawkish.
NOW, the CPI will work in favor of Fed and NOT be as lagged, since its 18 month delay is now moving in tandem w Fed signals.
Ever since March, inflation has come down, albeit barely. Now, since October, it is dropping precipitously. That won’t stop… as long as Fed doesn’t stop it’s hawkishness.
So if inflation is off the table, and hence FURTHER THAN EXPECTED Fed tightening is off the table, then what risks remain?
China: lockdowns have been priced in. New lockdowns don’t matter.
Earnings: They will remain flat
GDP: 70 % Consumer driven and we have jobs
Black swan? Barring a black swan, I see almost no new risks to the market. Crypto? No. Already blew up.
So, again, big buying opp in my opinion. I’m not buying more of course, just trying to say we might be closer to out of the woods w the above logic.
What annoys me is this is all just common sense forecasting I am doing, and so I wonder why the “pros” didn’t say this all already, as if to say maybe there is something they have on their side that I am missing. But, I don’t think so.
They keep recycling these points daily and I think people are catching on to the fact that they hold no real water- LONG TERM- so buy now with such historical discounts and improving macro.
