Opportunity Knocks Pt 2 Stock Talk
The Oak Harvest team hopes you had a fun and safe 4th of July weekend. We wanted to start off the second half of 2022 on a positive note. So here amongst the slowing economic data and bad news on TV, here’s a table from JP Morgan showing the opportunity cost on investing of waiting until the ski’s clear and the government data confirms that the coast is clear, and GDP is growing again.
Let this data sink in. We’ve reviewed many of these prior periods already on prior podcasts to compare the stock market, economy, and election cycles. But these numbers should jump out at you. The stock market bottoms on average 116 days before government data tells you that the bottom in GDP has happened. That’s almost 4 months. In those 4 months the average return of stocks has been around 21%.
If you sit back and wait until the government economists tell you the economy is back growing, and GDP is turning up again? On average, you missed another 10% gain on top of the initial 21% gain for a total average recovery of almost 32%. 32%? That’s quite a bounce. Positive 32%, on average, before the much watched, and often quoted government data tells you the coast is clear. The Oak Harvest team tries to stress that by the time government economic data is reported, its backward looking and stale.
Opportunity knocks, almost always, when markets are more uncertain than normal, and when market volatility is high not low. Your highest returning investments will almost always come from those investments you make during economic slowdowns or recessions. When GDP growth is nonexistent or negative. Your highest returning, long-term, investments almost never come from investing during economic boom times.
I am Chris Perras with Oak Harvest Financial in Houston and welcome to our weekly stock talk podcast. Before we get into this week’s topic titled “Opportunity knocks part two”. And before we talk about what might be the most important chart and data series to both the stock and bond markets over the next 6 months, please take a moment to click on the subscribe button and click on the notification bell so you will be alerted when our team uploads our latest content.
Our investment team never expected 2022 to be a year of “buy the dips” or V-bottom lows. For long term investors, we have expected it to be a year of dollar cost averaging and dividend reinvestment. With a turbulent first half in the rear view mirror, we want to present some charts and data that we see as leading signs to what a very normal and strong 4th quarter finish to could be in store for late 2022.
First off, almost every investor is aware that the Federal Reserve has been aggressively posturing interest rate increases since mid-first quarter of the year. They have been doing this to slow down inflation rates.
Guess what? It’s working and few on TV are talking about it. The real time inflation rates, that are priced into the bond market, in real time, not waiting on stale government data, have uniformly topped, broken 2-year uptrends, and have rolled over lower. The 30-year, 10 years, and 5-year inflation rates have all been heading lower the last 1 to 3 months. We’ve charted those previously. The last maturity to head lower is perhaps the most important one to near term stock volatility and returns over the next year or two. That’s the 2-year break even inflation rate.
It peaked around 5% at the end of March, dropped 1.5% since, to 3.5% and looks headed to 2.5% much the way all its longer-term inflation rates are. This should be a good early sign for the markets looking out to later in 2022 that the Feds inflation fight is working.
Lumber, is almost always a better early indicator on the domestic economy than the often quoted “Doctor Copper”. Here’s a daily chart of lumber. Many on TV have pointed to it having dropped over 65% from it’s highs a year ago as a deflationary signal. We warned of its weakness last November. In our work, these individuals pointing to it negatively are late to this observation.
Lumber now looks to be nearing a bottom as it is First in and first out. This is even though housing demand looks to have peaked. Lumber leads expansions up, and contractions down and this chart to our team is saying good things for later in the summer and year end 2022. Looking at this chart on lumber, I recommend you Build the fence you’ve put off for a few years.
If an investor waits for the “official” inflation data to roll over, most likely you will be late and the markets will have already moved substantially higher off its lows. The first table we shared shows how much of the markets return you missed waiting on the government economic data to confirm what stocks usually know in advance.
Viewers, remember that over shorter time frames stocks tend to behave around a combination of sentiment, expectations, and momentum. In layman’s terms, stocks tend to reflect are things getting better or worse for a company. Toward extremes, both to the upside and downside, many investors, due to their enormous size, those who need to buy or sell millions of shares, must start selling before they see a top in fundamentals, and they must start buying before they see the reported low in how bad things are. They need a very long runway to establish meaningful positions for their funds. Stocks usually trough when things are still looking cloudy and uncertain and why they peak when things are still looking rosy and perfectly clear.
Finally, I leave you with two final charts. The first is the S&P500 year to date. Yes, its abysmal. It’s Down and to the right EXCEPT for a brief up tick at the end of 1q22. The second chart. Well it might be the most important chart to both the stock and bond markets. What is it? Here it is.
It is the component of 10-year treasury interest rates that represents “real growth”. Remember there are two components to a Treasury yield. We’ve gone over these a few times on previous podcasts. The two components are first, Inflation and second, the real growth yield. You add them together and you get the interest rate you see on Treasury bonds, also referred to as the nominal Treasury yield. The inflation component of interest rates broke down weeks and months ago. That’s a good thing for those worried about inflation.
The second chart here is the other component of nominal interest rates. It’s the 10-year real yield component. As you can see, it’s up and too the right. Something you do not like to see in the bond market when you are talking about yields because it means the price of your bonds are heading down. This yield has risen almost 200 basis points or 2% year to date. That’s a massive increase in 6 months and its largely why the PE on the SP500 has contracted from over 21-22 times forward earnings to around 15 to 16 times currently.
Notice in late March, the S&P500 rally occurred as the 10-year real yield was no longer rising. This real yield component was rising almost every week during the second quarter and guess what? The downdraft in the S&P 500 has seen almost no sustained bounce.
But all that is in the past, and now the 10 -year real rate is charting the same pattern inflation did a few months ago. It looks to be peaking as worries are highest. We will share this chart more throughout the upcoming podcasts, but don’t be surprised if things start to look a little brighter throughout the 2h in the markets, before things in the economy and government statistics do. If this specific indictor breaks down in the upcoming weeks and heads lower there will likely be a lot more green days in stocks than we got in the first half.
Our team here at Oak Harvest knows that the first half of 2022 has been a trying time for those in the equity and bond markets who are not trading oriented. Almost all financial markets, regardless of asset class, have sustained higher volatility this year. This volatility is a harsh reminder to investors that stocks do not always go up. Remember, unlike the insurance markets and those tools, there are no guarantees in the public equity markets. The Oak Harvest team knows that sharp market moves drive emotions and the urge to make changes to what are supposed to be longer term asset allocations.
If the ongoing market volatility is making you feel uneasy, give us a call, and schedule a meeting with an Oak Harvest advisor. Our team does have insurance-based tools that do not have the volatility of public markets. However, we remind you, that these investments will also have lower long term expected returns for your savings and retirement.
At Oak harvest, we think our clients are best served by us helping them plan for their future needs, instead of focusing on the past. The future and stock markets are always uncertain and that is why our retirement planning teams plan for your retirement needs first, and your greed’s second.
Give us a call to speak to an advisor and let us help you craft a financial plan that helps you meet your retirement goals. Call us here at 281-822-1350, and schedule an advisor consultation. We are here to help you on your financial journey into and through your retirement years.
CFA®, CLU®, ChFC®
Chief Investment Officer, Financial Advisor
Chris is a seasoned investment professional with over 25 years of experience working with some of the most successful money management firms in the world. Chris has made it a point in his career to adapt as the market landscape changes, seeking to utilize the appropriate investment strategy for a given market environment. His transition from managing billions of dollars at the institutional level to helping individuals and families retire is guided by a desire to see first-hand the impact he is making in the lives of clients at Oak Harvest.