Good news = Bad news

Dear Mr. Market:

Last week was a microcosm of how stock market headlines can really lead you to hear one thing yet see another. For a while now we’ve been barking about how the FAANG stocks have artificially propped the market as there are some serious underlying health concerns. As a reminder for our newer readers, FAANG refers to the five major U.S. technology companies – Facebook (FB), Amazon (AMZN), Apple (AAPL), Netflix (NFLX), and Google (GOOGL). These household names have driven the markets and camouflaged some warning signs of risk on the horizon for quite some time. If you want a peek under the hood or a refresher on just what their impact, valuation, and market caps are relative to the broad market, please click here. (pay close attention to figure 18 which shows market cap with and without FAANG as well as Figures 13 & 14 for some relative earnings/revenue performance)

So…what happened last week? Why did the markets get hit so hard? It was indeed a rough week but then again not too many weeks feel all that bad when we take a quick look in the rear view mirror. (last year there were some mornings when the stock market was down literally -9% before you had your first sip of coffee) Albeit not a pleasant memory, don’t ever forget that (we’ll touch on why later in this article).

Like many wealth management firms and financial advisors, My Portfolio Guide, LLC is often preaching the long-term game and trying to show clients that looking daily ( or even weekly) is simply too short a time horizon. That said, the reason we bring up last week is that almost all positions that would normally benefit from indications of higher inflation suddenly got hammered. Last Friday was a nasty way to end the week but Mr. Market woke up after the weekend in his usual irrational state of mind and rallied back….but basically on no real news. We’ve seen markets sell off on perceived good news and vice versa. Stay rational because Mr. Market can stay irrational longer than you can hold your poker face.

From a major asset class standpoint, Gold and Commodities got clobbered which ironically is where you want to be if you still think inflation is on the horizon. The Dow Jones dropped -3.40% with the S&P 500 faring better at only down -1.87%. Looking a bit closer at the S&P, however, it was the continued tug of war between value and growth. S&P 500 growth stocks stayed flat at +0.25% whereas S&P 500 value stocks lost -4.13%. The scene was similar in Mid and Small caps. (Mid cap growth lost -3.65% vs value at -6.25% and Small cap growth -3.38% vs value at -5.74%) If you’re diversified you have exposure overseas, and those did better, but not by much. The MSCI EAFE (developed international) lost -2.40% and Emerging Markets did the best of group only losing -1.45%. Lastly, if you looked for shelter outside of equities, your bonds saved you a bit by holding roughly even at +0.11% for the U.S. Aggregate bond index.

If we peel back one more layer of the onion and look at which sectors got hit the most, it’s again focused on the inflation trades (that apparently Mr. Market temporarily ditched). Materials and Financials got slammed -6.28% and -6.17% respectively. Industrials is another sector that we’ve liked and that saw a drop of -3.75%. Tech was the only positive on the week…if you can call it that, with a +0.10% return. So why regurgitate all the weekly returns from the market if one of our main reminders is not focus on short time horizons?

The main reason is that we’re reminding you that what we saw last year was completely irrational and the definition of a black swan event. The recovery (again….if you want to call it that) was also a mind twister and it’s made people become poor investors with very unrealistic expectations. We’re being conditioned to think that market drawdowns of -40% are brutal but that they come right back. The same thing happened towards the tail end of 2018 when the stock market dropped almost -20% only to come right back only a month later in January of 2019. Totally normal…right? Wrong. Matter of fact, it’s not normal and as a true investor you should count your lucky stars that you or your advisor didn’t panic and sell at the bottoms but more importantly try to learn something from this lesson. We’ll take the “recovery” now but there’s nothing normal about it. Be cautious of economic reports trying to make apples to apples comparisons because in times past we’ve never spent money in such a reckless fashion; especially money we don’t have. Additionally, get your mind ready to deal with a stock market that does not recover right away. While that doesn’t mean you should bail out of stocks it does mean that you need to retrain your mind to think everything comes right back and is instantly fixed. We live in a world where we FedEx things overnight, order things on Amazon and get them the next day, or warm up food in less than a minute….yet real investing doesn’t work like that.

Until last week the Fed’s Chair, Jerome Powell, has categorized inflationary pressures as “transitory” and to quote him he said that the FOMC is “not even thinking about thinking about raising rates”. Some of the estimates on getting back to pre-Covid level type activity are almost three years out. The Fed making hawkish statements crushed gold along with commodities, flattened the yield curve, and awoke the U.S. dollar from its coma. Yet Powell clearly referenced demand shifts, bottleneck issues, and labor constraints, which to us, all sound like inflationary concerns (and therefore the longer-term trades) are still justified. We still see the risk of higher prices coming and while this posture (gold, commodities etc) got dinged up this past week…the year is far from over!

One last thing to note about inflation is that we’re not seeing it in Europe and Japan quite like we have here. Both areas outside of the U.S. have also lagged in vaccination numbers and therefore a full reopening of the their respective economies. Just buckle up for a bit as volatility is coming. In the near-term some good data may be interpreted as bad news for the stock market. We may also see Europe outperform U.S. markets for a stretch. Watch (but don’t panic) when the Fed may talk more about raising rates in August. When, not if, the market reacts poorly at that point, this will likely be the best time to reallocate a final touch into equities before year end. We’re not in the business of timing markets of making wild predictions from a dusty crystal ball, but even if we get a -10% standard market correction, don’t be surprised to see the S&P 500 finish near 4,500 (currently at 4,276). While we don’t particularly care or follow the Dow Jones, many still do, so watch for an all-time record of 36,000 (currently at 34,436).

Until next time….and as always…turn off that television (or social media) and go enjoy some sunshine, friends, and family this weekend!

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