Financial Insights- May 13, 2022

What Were They Thinking?

About three weeks ago, Fidelity, one of the largest 401(k) providers, announced that clients could invest up to 20% of their retirement funds into Bitcoin. Perspective$ readers know that, for most investors, we are not big fans of digital assets at this point in their life cycle. We continue to evaluate Bitcoin and other cryptocurrencies. And while this asset category may one day make it into the mainstream, we don’t think today is the day.

Why? First, the investment is way too volatile. About a year ago, the price of Bitcoin topped out at $58,238. By mid-July, it fell to $29,790 – almost 50% less value. It peaked again in early November at $67,580 and then sank to $36,457 around mid-January. Today, it sits at about $31,000 – a decline of 54% in five months. Is Bitcoin or cryptocurrencies where you want to invest 20% of your long-term retirement plan?

It is hard enough to educate 401(k) participants to make informed decisions on investments that have been around for a long time and have plenty of historical information. The information about the risks of digital currency is not abundant and difficult to find. We think this is an ill-conceived decision that could come back to bite investors and Fidelity itself.

Here is the good news. The 401(k) corporate sponsors must decide whether to make Bitcoin available in their respective plan. While some may do so, we don’t plan to invest Bitcoin in our clients’ $200 million 401(k) plans. The plan fiduciary, usually the business owner and/or top executives, potentially takes on a great deal of risk. Do you want that risk?

Market Down Short Term, but Look at the Long Term

Once again, we find lots of volatility in the markets, and April showered on just about every asset class. Through April, the S&P 500 was down about 13.5%, and it was the worst start of the year in a long time. April itself saw the S&P index decline 8.7%. The carnage continued into May.

As long-term clients know, we do not believe in selling at a time like this because it is a natural, although uncomfortable, part of market cycles. Over the past 100 months through April 30th, the index has increased 12.3% (total return) annualized; over the last 200 months, it gained 9.8% per year, increased 8.8% over the past 300 months, and averaged a positive 10.8% over the past 400 months. Now is not the time to panic, but to take advantage of depressed prices even though they may go lower. That is why we believe in easing into the markets. (Source: Standard & Poor’s)

Finding Solace by Looking to the Past

Recent market volatility has brought angst to even the most tranquil of investors. We find it prudent to look to the past during these tumultuous times to contextualize them within the bigger picture. Four points to keep in mind:

1. Pullbacks are common and healthy for markets. Over the last 40 years, the market (represented by the S&P 500 Index) has had an average drop of 14% at some point in a given year (down 16% YTD). (Source: J.P. Morgan Asset Management)

2. Remaining invested over the long term is still the best strategy. Over the last 50 years, if you had randomly picked just one day to invest in the global stock market, you would have had a 53% chance of making a positive return (basically a coin flip). If you remained invested for a quarter, your probability of a positive return increased to 66%. That probability increases to 73% if held for one year and 94% over a 10-year period. (Source: Nutmeg)

3. Trying to time the market is potentially very costly. If you were invested in the S&P 500 over the last 20 years but missed the 10 best days in the market, your return would be 45% lower than someone who remained invested. Even missing the best 5 days would lower your return by almost 30%. (Source: FactSet Financial)

4. And there’s never a bad time to get started. If you made your only purchase in the S&P 500 at the market top on October 9, 2007, then almost 15 years later you’ve more than doubled your investment, excluding dividends. With dividends reinvested, you’ve earned an average annual compound return of 9%—about the market’s long-term average. Worst timing of the century, historically average equity return. If you bought the Index on February 19, 2020 (right before the pandemic), your capital without dividends is up about 18% in two years, and with dividends reinvested, you compounded it at 9% per year—the worst timing of the pandemic, again, historically average equity return. (Source: FactSet Financial)

Every investor’s lofty goal is to buy low and sell high, yet simply avoiding a panic-induced liquidation could be the most prudent investment strategy one could make – and it does not require market timing. While past results are not a guarantee of future performance, history has proven time and again that betting against the market has been a losing proposition over the long term.

Younger Women Making Smart Money Moves

Fidelity’s “Money Moves Study” found that women younger than age 36 are making significant and impactful investment changes by opening either brokerage or retirement accounts earlier in their lives. Interestingly, 36% of surveyed women over the age of 36 “regret waiting too long to start saving for retirement.” 

Why is it important to start earlier? Young investors who start saving and investing early maximize the benefits of compound interest. Like Fidelity, we are encouraged by younger women breaking down financial boundaries and by starting to invest earlier in their lives.

History of the Federal Reserve Bank

In December 1913, Congress passed The Federal Reserve Bank Act creating a national bank with 12 district banks to blunt the financial power centralized in New York. On two prior occasions, America formed a central bank. The first time was Thomas Jefferson’s brainchild, but the second and last attempt ended during President Andrew Jackson’s time in the White House.

The timing of the Fed’s creation was ideal because it funded World War I for both America and much of Europe, and again during World War II. In those early days, the bank was controlled by the politicians. By the end of Truman’s presidency, the 1951 Accord made the Federal Reserve independent of political influence, and that has continued until today. The Fed has a dual mandate: 1) to keep inflation under control and 2) to promote “full” employment, which is generally considered to be a 3-3.5% unemployment rate.

According to the government, we have full employment; however, we still have fewer workers than we had at the start of the pandemic by about 1 million jobs. We have also created about 6.6 million jobs over the past 12 months. Since we have over 11 million available jobs, it is a job-seekers market. Employers need more people to fill these openings and future jobs. Thus, we are seeing higher wages to attract people out of retirement or off the sofa. Thus, the mandate of “full employment” is being fulfilled.

Inflation is often defined as too much money chasing too few goods. In short, when the things that people want to buy are in high demand, but the supply is small, the cost goes up. From the Federal Reserve’s point of view, the ideal inflation rate is 2% annually. For many years, the rate was below this number despite the Fed’s desire to see it grow. Then, BOOM, out of nowhere, inflation started creeping up and then accelerating. How and why did it happen?

There are two sides to this coin. When the pandemic hit in early 2020, America started shutting down, and employers began laying off or firing people in droves. This, in turn, led to the supply of goods dwindling, but it was sort of okay, because no one was buying anyway. But as we came out of the pandemic, all those things that we wanted and yearned for while we were carefully protecting ourselves, slowly and quickly became a desire that overwhelmed the available supply. Then on top of that, the supply chain issues mounted as businesses re-started. Too few goods are being chased by too much money. Bingo! Inflation.

But where did the money come from? Two things happened. Congress passed the American Rescue Act which was subsequently signed by President Trump. It threw $1.9 trillion into the hands of people all over the country, much of which went unspent on anything that wasn’t essential. Who could go anywhere or do anything? Where did this money come from? It came from the Fed who created it out of thin air with its magic checkbook providing the money the government didn’t have in the first place. How much is $1.9 trillion? At the time, it was about the size of Canada’s entire Gross Domestic Product (GDP). A whole country’s worth of money. WOW!

As people got shots and/or built immunity from COVID, they started spending money with the funds that they saved over the previous year. But too much of a “good” thing, can lead to a bad outcome. In March of last year, Congress passed, and President Biden signed, a new bill creating another $2.1 trillion package of goodies (cut down from $4 trillion). Now American’s had even more money to spend. Where did it come from? The same place…the Fed once again created it. Too much money chasing too few goods and presto…inflation.

The Fed is now trying to control inflation by raising interest rates making borrowing money for both individuals and businesses more expensive. After all, for most of the past two years, it has been free money for everyone. Raising rates will have the desired effect in time, but it usually takes 12-18 months for things to begin slowing down. But do things have to slow down with rising interest rates? Probably, but the Fed needs to find the sweet spot between just enough pain without tipping the economy into a recession. It is often referred to as the Goldilocks scenario. Not too hot and not too cold.

Do higher interest rates mean no growth and even worse a recession? Remember how well things were going in 2018 and 2019? Hard to think back that far sometimes, isn’t it? The 10-year Treasury had an interest rate that varied from 2.4% to 3.2% and that was considered low by historical terms. Today, it is hovering around 3%.

But there is more to the issue, and it is not being addressed…at least not yet, and that is the supply/growth of money. Paul Volcker famously ended the inflation of the 70’s and then again in the early 80’s by raising interest rates and slowing the growth of the money supply. The Fed continued with this approach until the late 80’s and then returned to the trying to control the economy with interest rates only. This helped lead to the dot.com bust and later the financial crisis which created the Great Recession. 

So, does this mean we are headed for another recession? We will have another recession one day, and no one knows for sure when it will happen. Most say it will happen next year, but that is just a guess by economists who have been wrong many times before.  But here is what we do know. The American free enterprise system is the greatest economic engine in history, and with every recession we come out stronger and better. At times like this, it is easy to fear the worst and make money mistakes. It makes no sense to sell and turn a paper loss into an actual loss.

Inflation is Causing Stress and We Thought These Might Be a Stress Releaser – Humor…

HOW BAD IS INFLATION?

• My neighbor got a pre-declined credit card in the mail.
• CEOs are now playing miniature golf.
• A major oil company laid off 25 Congressmen.
• McDonald’s is selling the 1/4 ouncer.
• A picture is now only worth 200 words.
• Called to get Blue Book Value on my car. They asked if the gas tank was full or empty.

IMPORTANT DISCLOSURE