As we’re all aware, Russia’s decision to invade Ukraine is being universally denounced and condemned the world over. Economic sanctions imposed on Russia and the impact of those sanctions on the Russian economy have been significant. The Russian stock market remains closed after plummeting over 35% while the value of the ruble has plunged by approximately 30%. Dozens and possibly hundreds of companies around the world have halted business operations in Russia, including many of the largest American corporations. Over 2 million Ukrainian refugees have fled the country since the beginning of the invasion while thousands of Ukrainian citizens have taken up arms to defend their homeland. Although there have been discussions between both countries little progress has been made and both military and civilian casualties continue to mount. While it might seem callous to discuss the war’s impact on the capital markets and investing while the Ukrainian people are fighting and dying for their freedom and national sovereignty, it’s our job and our responsibility to provide counsel to clients regarding the markets and their investments, irrespective of global events, even during this kind of terrible geopolitical situation. And that is the purpose of this letter. We thought the best way to do this is using a frequently asked questions (FAQ) format, as follows:
The stock market (S&P 500 index) has declined about 11% since January 1st. Is it likely that stocks will decline further?
Unfortunately, no one can answer that question but market declines caused by military actions have historically been short lived. While we think the market could decline further before eventually bottoming – as always happens – lower stock prices and attractive valuations create opportunity for long term investors who have cash available to invest and the desire and discipline to do so. With U.S. retail investors holding over $1.5 trillion in cash and institutions holding over $3 trillion, there’s plenty of cash available to buy equities. One positive aspect of the recent market decline is that it’s brought stock valuations more in line with historical averages and shaken much of the “excess” out of the market, especially for companies that were trading at extreme valuations. Some of these “high flying” stocks are down as much as 50% or more from their all-time highs. As to the market in general, in response to the Russian invasion many analysts and strategists have revised their year-end S&P 500 targets downward with estimates now ranging from 4,000 to 5,000. For reference purposes the S&P 500 price level today is 4,250. This wide range reflects the high level of uncertainty in the market. While discussing annual price targets might make interesting conversation, price targets provide no real value to investors as stocks, by their nature, are multi-year investments. How stocks perform over any short period of time – whether that performance is positive or negative – should be irrelevant to investors who are long term oriented, assuming they have the appropriate allocation to stocks for their financial and personal circumstances, their age and their investment objectives.
The price of oil has skyrocketed in recent weeks, recently hitting $130 a barrel. How damaging will high oil prices be to the economy and the markets?
Higher gas prices act as a defacto “tax” on consumers, reducing their disposable income. They’re also inflationary as higher gas and diesel prices impact transportation costs which can lead to higher prices for consumer products. But despite what many people think, higher oil prices aren’t necessarily a harbinger of lower equity prices. For example, from 2011 through 2014 oil (WTI) traded around $100 a barrel. During those four years stocks produced an average annual compound total return of over 12%. There’s an old saying that “the cure for high oil prices is high oil prices”. In other words, with oil trading above $100, producers have a strong motivation to increase production, which should eventually bring prices down, depending on the demand side of the equation. Last, as a point of interest, after adjusting for inflation, $100 oil in 2011 equals $123 today, right about where WTI is currently trading.
Will the war, U.S. economic sanctions against Russia and the Fed raising short term interest rates push America into recession and a bear market?
Although always possible, a recession in 2022 seems unlikely to us. Leading Economic Indicators (LEIs), which have been effective predictors of recession in the past, remain positive. While U.S. GDP estimates have been revised downward since the invasion, the consensus remains for GDP growth in the mid to high 2% range for 2022, pretty far from two consecutive negative quarters of GDP which defines a recession. Considering that GDP growth averaged just 2.2% annually over the past decade with strong equity performance, a GDP print in the mid 2% range this year, if that’s where we end up, seems quite reasonable. Last, even post-invasion, analysts expect earnings growth in 2022 for S&P 500 companies of around 8% and significantly higher than that for mid-cap and small-cap stocks.
Is the Fed still going to raise short term rates several times this year to bring down inflation?
Yes. There’s been no indication from the Fed that their plans have changed although the first hike, which many people thought might be 50 basis points (a basis point is 1/100th of a percentage point), will now be 25 points. Chairman Powell has made it clear that the Fed will remain nimble and rely on data to make future decisions regarding rate hikes. However, with unemployment at 3.8%, a very low level, we should assume the Fed’s focus will clearly be on “price stability”, meaning containing inflation.
Last, we’ll leave you with a few observations that might be helpful.
Over the past three years equities produced total returns well above their average annual compound total return (including dividends) over the past century of approximately 10% (31.2% in 2019, 18.02% in 2020 and 28.47% in 2021). After a strong market rally such as this, it’s not uncommon for stocks to experience either sub-average returns or negative returns for a period of time, from a few months to a year or even longer. This is why it’s imperative to not just understand the reality that stocks are long term, multi-year investments but to embrace that reality and not allow short term political or financial events to derail your long-term investment plans. Consider the following (using the S&P 500 index as a proxy for the stock market):
• Stocks historically, on average, experience losses one out of every 4 years but those losses have always been temporary.
• Short term price volatility is normal with stocks experiencing intra-year price declines of 10% or more 80% of the time.
• The average intra-year price fluctuation of stocks from high to low over the last 35 years is about 14% (which is more than where we are this year as this is being written).
• Over 93 calendar years, beginning in 1928, stocks have lost 30% or more only 3 times and two of those years were during the Great Depression of the 1930s. In contrast stocks have earned 30% or more 18 times.
• Over 93 years the market has lost 20% or more just 6 times but has earned 20% or more 34 times.
Naturally, past performance is never a guarantee of future results but we do believe that history can provide a valuable perspective.
In closing we realize that periods like this are stressful for our clients and that it’s our job to help you navigate through these storms until the sun shines once again……….as it always has. Please feel free to reach out to us if you have any questions or if you’d like to discuss the markets. As always, thank you for you trust, your confidence and your business.
The Sutton Wealth Advisors Investment Committee
W. Edward Sutton Zachary Sutton CFP®, EA Matt Bertoncini CFA