Way Back to 1974 Is History Repeating Itself | Stock Talk Podcast
2022 is nearing a historically bad first three quarters for investors in stocks and bonds globally in many ways. The main culprit is our Federal Reserve vowing to bust inflation now by implementing the most aggressive monetary tightening the world has seen since 1994. With most stock indexes down -20% or more, and many bond investors sporting similar-sized losses, the lingering question many investors are asking is “Are we there yet?” Are the “lows in for the year?” It’s the question asked on a daily basis, with most on T.V. now siding on the side of no. We, like others, don’t know for sure. The key signs we are looking for remain a peak in real interest rates and a peak in the U.S. dollar.
However, frequent watchers know that we like to look at previous time periods for clues to the future, as much of what happens in the financial markets is based on behavioral finance. Much of what happens does repeat and rhyme time and time again. We’ve discussed 2022 being a mid-term election year. We’ve compared it to a number of other mid-term cycles when interest rates were increasing, the Fed was tightening monetary policies, there was geopolitical volatility around the world, and we had bear market declines.
I am Chris Perras with Oak Harvest Financial Group in Houston, Texas and welcome to our weekly stock talk podcast, keeping you connected to your money. Before we get into this week’s topic, “2022, A 1974 replay? A Long, Long, Time ago”, 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.
2022 has gone well beyond our correction call we set out in the 4th quarter of 2021. We now sit in the first legitimate bear market investors have experienced in both percentage decline and time in years. It has not been fun for anyone unless you are a hedge fund using a managed futures strategy that almost exclusively uses a trend-following approach. And just to put that in perspective, those strategies were horrific and underperformed almost universally for 10 to 12 years. Not months. Years.
Between the current inflation readings, what’s going on in the energy markets, and geopolitics, we’ve had a number of questions asking if we are repeating the 70s, a period marked by high volatility in markets and the economy. I can’t tell you we are or aren’t, but I can tell you we are currently mirroring the timing, progression, and pattern for the cyclical decline in stocks that took place during the mid-term election year in 1974 and led to a very good 15-18 month run in stocks.
Here’s a flashback to that year. Richard Nixon was President. He was impeached and resigned during the summer, and Gerald Ford took over. Sounds a bit like the political events in the U.K. now? There was a massive oil shock in 1973-74 caused by our own oil embargo policy against Middle Eastern oil producers. The price of oil went up fourfold in 12 months as America was far more dependent on imports for oil back then. Sounds a lot like Europe this year. The dollar was depreciating on the back of the end of the Bretton Woods monetary system that had linked the value of the dollar to the price of gold. This increased the price of all imported goods to the U.S., causing another factor pushing inflation higher.
Unlike 2022, in 1974, the FOMC focused on government budget deficits, oil price shocks, and “excessive” price and wage increases by firms and labor unions, not monetary policy. The Fed raised rates but kept interest rates relatively low, even in the face of rising inflation.
Over the next ten years, core PCE inflation remained above 5%. It was nearly 10% twice during that period (from late 1974 to early 1975 and again from late 1980 to early 1981). This period of high inflation caused big swings in real economic activity, and the U.S. experienced three recessions from the mid-1970s to the early 1980s. We don’t want that outcome now; hence the Fed is trying to move rates up fast now, given that they started moving late.
Which takes us back to the question? Are we there yet? I don’t know, have interest rates peaked? Has inflation peaked?
The real-time data says yes on much of the inflation data. The Feds data says no. Some interesting data from Strategas Research shows that rises and declines in inflation are historically very symmetrical in price and time.
Going back to 1974, GDP contracted by -2.3%. Year to date, we’ve already had two negative GDP quarters in the first half of 2022. Check that box. In 1974, the CPI rose 5.75% points to 12.2% over five quarters. It peaked in November 1974 and fell 6.06% points over the next five quarters. Almost identically symmetrical in time and price. When did the S&P500 trough and pivot up in 1974? Early October, about two months before inflation peaked and months before the economic data started to improve. The markets started accelerating higher on the marginal moves by the Fed and real-time interest rates peaking. No pivot was needed.
Take a look at the overlay chart of the S&P500 and interest rates in 1974, provided my Alpine Macro.
As you can see, the correlation between interest rates, in this case, shorter-term rates that are closer to what the Federal Reserve controls, and stocks were VERY tight. Just as it has been year to date. We’ve pointed out the need for two real-time securities to peak as the key for a sustained pivot higher in stocks. One, we need real interest rates to begin peaking. They mainly control the markets’ P.E. and equity risk premiums. And secondly, the markets want to see the U.S. dollar’s strength waning as the dollar is still the safe haven currency for the world.
In 1974, did you have to wait for companies to tell you that business was improving? No, by then, the markets had already rallied materially. Stocks bottomed in the 4th quarter of 1974 when earnings peaked and began to decline. Large-cap stocks were up over 35% in 1975, even though the earnings recession they felt went from the 2nd half of 1974 through the first half of 1975. Why? During periods of high inflation, earnings can be a very lagging indicator. Why? Because earnings are measured in nominal dollars, which is a combination of units and pricing, while economic recessions are measured by the economists in “real” unit output ex-ing out pricing effects.
Besides the current economic, geopolitical, and federal reserve positioning, another comparison of 2022 and 1974 is volatility. According to LPL Research, year to date, the percentage of days that the S&P 500 has seen a positive daily return is just 43.5%. This is the lowest value since? 1974. Unfortunately, years with such low percentages of up days normally do end with negative returns, with only 1982, another mid-term election year, ending with a positive return.
The Good News:
The good news from this data is that the year following on from one with such few up days tends to see well above average returns, with an average and median return of 12% and 17%, respectively. The two mid-term election years, 1974 and 1982, saw follow on years returning 31.5% in 1975 and over 17% in 1983.
If the ongoing market volatility is making you feel uneasy, you are not the only one. According to Nick Colas at DataTrek Research, it’s been a near-historic year for concentrated downside market moves in or around inflation data releases and Fed meetings. How concentrated? According to Nick’s research, as of Oct 10th, the SP500 was down about -23.6% YTD. Only nine days accounted for the entire market decline year to date. Those days were all clustered around the Fed speaking or CPI announcements. Ex those nine days? The S&P 500 would be up +9%. Yes, you heard that right. That’s how macro the markets swoon and downturn has been year to date.
Nine days, all clustered around the Fed and CPI data releases accounting for the bear market move down in 2022. Listeners, only computers can trade that fast and that concentrated. I’m not saying it doesn’t hurt longer-term investors or count on the scorecard. However, we have seen that these same program trading algorithms can flip and trade the market up just as fast when whatever data series or Fed speech they are keyed off of “flips” the other direction.
If you’re feeling uneasy because of this market volatility, give us a call, and schedule a meeting with an Oak Harvest advisor. We will sit down with you and help you and your family do the math to figure out if you will be able to meet your retirement goals and needs.
Our team does have insurance-based tools that do not have the volatility of public markets. However, we remind you that these investments may also have lower long-term expected returns.
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 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 (877) 896-0040, and schedule an advisor consultation. We are here to help you on your financial journey into and through your retirement years.
I’m Chris Perras and from everyone here at Oak Harvest, have a blessed weekend.
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.