The Market - Base Case & Worst Case
A reflection by Wayne Wagner Jr., ChFC
I thought we'd take a minute and talk about what's going on in the markets. We need a general idea of the base case, the worst case, and what could realistically happen.
Burning Off the Government Spending "Rocket Fuel"
In the near term, our economy is trying to burn off the "rocket fuel" that the government injected into our economy during COVID in the form of about $17 trillion worth of capital.
The engine of the economy was running just fine prior to COVID. COVID hit and it felt like the engine was going to break down. Politicians were afraid so they figured, "We can't fix the engine. So we'll just run rocket fuel through it to try and get it to maintain its same pace."
Well, they did that in an enormous way, but now, COVID's just about over. Sure, we've got some little peaks and valleys in the caseload, but the bottom line is that COVID is moving into the history books at this stage.
We still have $17 trillion worth of rocket fuel in the economic engine. So we've got to burn that off before we can get back to kind of a new normal.
The Base Case: Abrupt, Unpleasant, but Effective
I would suggest that the base case here feels like this. When you're on the highway and you're doing 90, you get to the off-ramp where you need to drop to 30. It feels like somebody put both feet on the brakes, right?
The same thing's happening here. The economy has been going at 187 miles an hour, and now we need to get back down to the regular speed limit and burn off that government-injected capital.
What Does It Mean to "Burn Off Capital"? How Does That Happen?
Unlike the simple act of slamming on your car's breaks, there are a lot of different levers that get pulled throughout the economy to help us do that. Here are a few.
Increasing Interest Rates
We've all been watching the Fed announce its plans to progressively raise the interest rates. In theory (and history), this tool is used to accomplish anti-inflationary goals like slowing the acceleration of the housing market and depressing the borrowing markets.
Downtick in stock prices
We're also all watching get a bit of a downtick in the stock market. While this isn't as intentional as the Fed, the natural occurrence serves an important purpose we'll discuss in a minute. At the moment, the S&P 500 is down about 15%. The NASDAQ is off in bear market territory down a little over 20%. We've got a pullback in stock prices.
Increasing earnings rates
This is a metric we watch closely, especially in relation to stock prices. As prices decline, we want to still see growth in earnings reports. The relationship between price and earnings is a critical balance in the health of the stock market.
How the Market is Helping
Some days, it seems like it would be really helpful if we could actually just set a couple of trillion dollars on fire and smoke it. The market is helping us there too. Bitcoin is down about $600 billion over the course of the last month or so, and many of the large-cap companies, the mega-cap companies in the stock market have come down pretty significantly.
The silver lining here is that some of the valuations we're seeing from these companies (i.e. Amazon) on a P/E ratio basis (price to earnings) are about where it was in April of 2020.
The valuation of Amazon right now is at the same valuation it was at the bottom of the market in 2020 on a P/E ratio basis. Their earnings have come up and the price has come down over 30% at this stage.
That's a base case scenario that hey maybe we're going to find a smooth landing here. It may be we're going to find a new base to start building off of, and that's good.
The Worst Case Scenario: We Haven't Seen the Bottom Yet
Now, we do need to address the worst-case scenario. When we look back in history, we were down in 2000-2001 and then we got a crisis. After 9/11, all bets were off for a while.
The stock market peaked in October 2007, but by July 2008, the stock market was down 25%. At that point, everybody said, "Hey, we got a nice little bear market going. Maybe it's time to start buying stocks and get more aggressive." And then we got a crisis.
For anybody who's saying we're absolutely at the bottom now, the fact of the matter is we were 20 years into a downslide in 2000-2001 before the crisis came. We were nine months into a downslide in 2007-2008 before the crisis came.
Now, there's a chance we avoid a crisis and we don't know what the crisis would be. I had somebody this past week tell me, "Well Wayne there can't be a crisis. They outlawed that after 2008." The fact of the matter is they outlawed the last crisis, they didn't outlaw the next crisis, right?
How Do You Create a Personal Plan Moving Forward
As it pertains to your personal financial plan, we want to be careful about how we're approaching asset allocation. We're doing some rebalancing. We're changing how we're approaching the bond market, specifically the allocation that we have towards fixed index annuities and things like that. That's especially important for clients who are closer to or in retirement.
We're being a little more protective of our clients' money at this point in time because we don't know how long this kind of long, slow burn-off process can go, and we want to be cautious about not getting into a crisis.
Remaining Vigilant, but Not Panicked
If you go on the internet, you can find all matter of things. There's a crisis around every corner, and there are some of those that are pretty legitimate.
We're watching the war in Russia and Ukraine because of significant factors like how much of the world's grain is grown in those two countries and the fertilizer comes out of Russia. Data points like that give us some pause and some concern about ripple effects.
But is that a crisis or is it just another speed bump? We don't know. A nuclear bomb would be a crisis, and we don't know what Mr. Putin over in Russia is planning at this point. There are always concerns and some seasons have more than others. At this point, we're being a little cautious. We're not cutting and running, but we are being a little cautious in how we approach things.
As always, please feel free to call us any time with your concerns, thoughts, or critiques. We are always here with perspective for the decisions ahead. Thank you so much for spending a few minutes with me here today.