Market Volatility: Short-Term or Here to Stay?

By Dean Barber

January 27, 2022

Market Volatility: Short-Term or Here to Stay?

Key Points – Market Volatility: Short-Term or Here to Stay?

  • What Is Fueling US Inflation?
  • Inflation As It Relates to Retirees
  • Accounting for Inflation within the Guided Retirement System
  • Reviewing the Financial Triple Threat
  • 19 minutes to read | 38 minutes to listen

Staying Calm Amid Market Volatility

Dean Barber: Thanks so much to those who join us on America’s Wealth Management Show. I’m your host, Dean Barber, along with Bud Kasper. I just want to start by saying, “Holy volatility, Batman.”

Bud Kasper: Yeah, no doubt. It is there.

Dean Barber: I’ve never been bungee jumping, but I feel like I’ve bungee jumped several times this week. I said earlier this month that we would have a positive year, but there’s going to be far more volatility than what we’ve seen. Bud and I have lived through volatile times on many occasions and have helped people through them. However, every time it happens, people get that feeling of, “Oh my gosh. Here we go again.”

Even though you know what to do from an intellectual perspective, think about what it must feel like for investors who haven’t experienced market volatility. They haven’t been coached through this, so they’re just sitting there anxiously asking questions.

  • When is the next shoe going to drop?
  • How far can this thing possibly go?
  • What in the world is going on?
  • What should I be doing with my money?

We know that a lot of those questions are on peoples’ minds right now.

Let’s go back to 2007. That was really the very beginning of the unwinding of the credit bubble that we were in that caused The Great Recession. Let’s talk about that because I want to set the stage for what people need to look for to determine whether we’re in a short-term bout of volatility or if this is the beginning of something far worse.

Bud’s Optimism that This Market Volatility Will Be Short-Term

Bud Kasper: I like your bungee analogy. You’re probably ready to pee your pants when you’re up there, but they’re safe at the end of the jump 99.9% of the time. I think that will hold true for our investors today as well.

It seems rather dangerous right now with investments in stocks, especially when you see the extremes that we’ve had in the downside of the market. But we’ve lived through this before. Yes, the circumstances are always nuanced or somewhat different than it has been, but it really isn’t.

We have things that need to be taken care of by the Federal Reserve and policies from Washington, D.C. But Americans usually come out on the other side happier than when they were in the fight.

Bud’s Prediction of the Subprime Crisis Was Spot On

Dean Barber: Some 15 to 20 years ago, Bud identified the subprime crisis well before we had an idea of what was happening. The idea was that the subprime crisis could leak into a prime loan crisis. If that happened, what would ensue?

It was quite terrifying very early on. 2007 wound up being a positive year. The markets were still positive in the middle of 2008. People could have been thinking, “Bud Kasper, you’re crazy. Things are good.”

It reminds me of that movie, The Big Short, where he was shorting all these stocks, but nobody would listen to him. The markets kept going up and he was getting squeezed. Finally, capitulation hit and the markets crashed. But that was the beginning of something far worse. How did you identify that, Bud? What were you looking at?

Distinguishing the Differences Between Short-Term and Long-Term Market Volatility

Bud Kasper: At that time, interest rates were becoming ridiculous. They were just going out of sight. People were crazy with what was going on in terms of mortgages and things like that. That was very difficult.

If people don’t remember what happened in 2008, the S&P 500 lost 38.5%, which obviously was a shocker for everybody. I think what people need to remember about that is that it took approximately three and a half years to get that money back after losing it.

For all the people out that are retired and ringing their hands right now, I’m right there ringing them with you. We come out on the other side of this generally well. We know what the fundamental reasons are for why the market is doing what it’s doing.

I don’t think this looks exactly like a repeat of what we had in 2007 and then in consequences of 2008. But we do have some issues that need to be identified and cured. The supply line is clogged, microchips are in short supply, and inflation is a drag on the economy and the stock market.

Bonds will not save your returns, at least not yet, like they did a year and a half at the onset of the pandemic. Bonds were a great place to be at that time, even though we were certainly at issue with it in the first quarter of that year.

The Federal Reserve is walking a tight rope. That tight rope isn’t clear yet in terms of what they’re going to do with raising rates. What will that do to economic growth and consequently, what is going to happen with stocks?

This Isn’t a Time for Guess Work

Dean Barber: I think you’re spot on, Bud. I want to dig into all that, but before we do, I want to make a very clear that this is not a time for guesswork. This is a time for understanding where you are and what your money should be doing.

There’s opportunity in volatility if you play it right, but there’s not a magic formula. There’s no rule of thumb for what everybody should be doing. It’s all going to depend on your own personal situation and what your financial plan shows that your money needs to do. We call that your PRI, your Personal Return Index.

The Pressure Is On for Jerome Powell

Federal Reserve Chairman Jerome Powell has really been feeling the brunt of the market volatility. If he had a theme song for 2022, it would be Under Pressure by David Bowie and Queen.

Bud Kasper: True statement.

Dean Barber: I would not want to be that guy right now. Bud talked about him being on a tight rope right now. The reason I say that Jerome Powell is under pressure is because I believe that the markets think that he did two things wrong.

  1. They think that he waited too long to begin the tapering of the bond buying.
  2. They think that he missed the idea that inflation was transitory.

Those are strikes one and two. The markets believe that strike three could be him overdoing it on the other end. Instead of guiding the economy and the inflation to a nice, smooth, soft landing, he’s going to overdo it on the other side when the markets are already looking at slowing economic growth and lower inflationary pressures through 2022 and even lower inflationary pressures through 2023.

Is An Economic Recession on the Way?

They’re afraid that if Jerome Powell overdoes it and gets strike three that the economy will go into a recession. I think that’s where all the volatility in the market is coming from. What do you think about that, Bud?

Bud Kasper: I don’t think so. I think that Chairman Powell and the people that serve on the Federal Open Market Committee with him have seen this before. I think that they are going to play it very close to the vest. They’re not going to rush. You’re not going to see more than a 25 basis points increase.

Dean Barber: A quarter of a percent.

Bud Kasper: They’re going to stick their toe in the water and slosh it around before they think about putting a second toe in. I don’t think that’s going to happen from that perspective. And I hope I’m right because it’s true that the consequences could be severe if it isn’t done correctly.

Dean Barber: I’m not saying that that’s what’s going to happen. I’m saying that is the source of market volatility right now because the market fears that could be the case. Since we’ve had strike one and strike two, could this be strike three? I think the Fed is walking a tight rope.

How Many Rate Increases Will We See in 2022?

We don’t know what’s going to happen with supply chain issues or what the next variant of COVID might be that could slow the economy again. There are so many unknowns. All the major banks and brokerage houses are now looking for four rate increases for 2022.

So, what does that do to the Fed funds rate? It raises it to 1% if they do it a quarter of a point every time like what Bud was saying. A 1% Fed funds rate is still an extremely loose monetary policy. I think where they’re coming down to is reducing the balance sheet and stopping the bond buying program. That liquidity is what has fueled the markets and the economy ever since March 2020 when COVID-19 hit.

The Chaos with the Ships and Chips

Bud Kasper: You’re right. I think one of the biggest issues for sure is ships and chips. We have the clogged shipping line and the chips are such a necessary thing, especially to the automobile industry as it continues to evolve into tech land. We’re all enjoying what the technology has done to our automobiles. It’s very exciting from that perspective, but if the shipping line is clogged and we can’t enjoy that.

I’ve got a two-year-old car that’s in the shop. It has a transmission problem, but we have a loaner that they provided us. the issue at hand is that we don’t know when we’ll get that car back. It could be 30 days, 60 days—who knows? That’s the result of what’s happening with this ships and chips.

In this case, both apply because there’s only two ways that they can fix the transmission—either replace it or find the parts. Well, the parts aren’t there. I think that personifies how one little area of our economy can be negatively impacted by the costly disruptions that we’re seeing in our economy.

Where Can We Expect Inflation to Go from Here?

Dean Barber: That disruption can do two things. It can cause inflation, which we’ve seen happen. It can also slow the economy. When you look at inflation year over year from 2020 to 2021, it’s hotter than it’s been in 30 years. At the same time, we were coming off some extremes on the other side of things. To think that inflation is going to do the same thing year over year from 2021 to 2022, I don’t think that’s in the cards.

I think the markets are thinking that we’re not going to get 7% inflation again. We’re not to get that kind of growth. Our GDP is probably going to come in at the 3.5% to 4% range. Inflation will potentially be in the 3.5% to 4% range as well this year. That’s still above the Fed’s target, which I believe is where Jerome Powell is coming in. I believe that stopping the bond buying program and starting to work down balance sheet is the right approach.

The Bucket Approach

The fear is that doing all three things at once can send things down. If investors are retired right now and relying on income from investments, they should always have two to three years’ worth of income in a very safe spot. That has been our message as CERTIFIED FINANCIAL PLANNER™ professionals to investors we’ve been meeting with. If you’re not doing that, you need to get there because you don’t know how this is going to play out.

The conservative way to do it as you’re heading to retirement or in retirement is through the bucket approach. Have some money that’s there for your spending needs in the immediate future. That can be as much as three years of your spending needs, your withdrawal amounts that you’d be taking out of your portfolio. It should be in something very, very safe.

Understanding the Sequence of Returns Risks

You should be looking at what you have in the market as seven-to 10-year money. You need to have a longer runway because you can always have the volatility. Bud and I talked about that at length during the Season 6 premiere of The Guided Retirement Show™.  We discuss the sequence of return risk and how to fight that off.

Here’s a quick example of that. I had a client reach out to me this week about what’s going on with all the volatility. He asked me what’s going on, where are we at, and what the plan is. I had to remind him that he has five years’ worth of income in an asset that is maybe going to make 2% or 3%. It’s very, very safe. It’s very conservative.

I told him to realize all the money that he has in the market today is money that he shouldn’t be touching until he’s five to seven years out from retirement. He shouldn’t be touching that.

We can handle market volatility. If for some reason we thought that this market volatility was going to turn into something greater, we would obviously take a more defensive approach.

Utilizing Educational Resources to Combat Market Volatility

If you don’t know exactly what your money needs to do for you to accomplish everything that you want to accomplish and you’re approaching or in retirement, this is a critical time for you. This is the time that if you make a mistake or if you do it wrong, the consequences can be life changing.

There are a couple of things I’d like for you to do. Whether you’re working or whether you’re retired, get copies of our Retirement Plan Checklist and 401(k) Survival Guide. Also, make sure to read our recent article about 7 Ways to Build the Best Retirement Plan and watch our Retiring with $1 Million video.

Then, I want to remind you about The Guided Retirement Show™. The Season 6 premiere is out now with Understanding Sequence of Returns Risks. It’s very relevant to what’s happening in the markets today.

Volatility can be terrifying and gut-wrenching. Make no mistake about it. It can make people fall prey to one of their strongest emotions, which is fear. But there’s another side of this. I’m talking about buying opportunity in certain areas. And where that buying opportunity is and when you take action on that buying opportunity could be something that could make for an even better year than what you and I are anticipating.

Don’t Let Fear and Greed Take Over

I mentioned earlier that this market volatility feels kind of like bungee jumping. If you’re queasy, you might not want to look at it. It’s interesting because people want to go from where their portfolio peaked and look at how much they’ve lost since then. You need to step back; you can’t do that. If you do that, that’s where these emotions of fear and greed can come in.

The only reason you should be doing that is by looking for opportunities within your portfolio. Do you have some money that you can now put to work in selective areas where price-earnings ratios have come down to a reasonable level because of the pullback? There is some growth opportunity out there.

Bud had a conversation this week with the portfolio manager of T. Rowe Price Capital Appreciation Funds. I’d like for Bud to share some insights from someone who has had a lot of success. What was your main takeaway, Bud?

Bud Kasper: Caution. I hold this guy on the highest pedestal possible because he’s been managing that fund since 2006. It happens to be a closed fund. New investors can’t get into it. However, his success has been extraordinary. It’s only had one down year since 2006, and you can guess which year that was.

Dean Barber: 2008.

Bud Kasper: Yeah. When you look at the compounded benefit that the shareholders of that fund have had all the way up to year to date, it’s mind-boggling how much better it’s done than the S&P 500.

We’ve Been Through Market Volatility Before

The ships and chips phrase I mentioned earlier was his phrase. He realized this problem we have with getting goods and services out to the people that need them so desperately and the impact of inflation at the pump and grocery store. All this is somewhat familiar, isn’t it? We’ve lived through these periods of time before.

The Biden administration wants to free up shipping, but it is hasn’t accomplished very much to this point. It hasn’t been happening. I know people that are in the trucking business who are having the same issues with getting personnel to drive these trucks.

More importantly, the personnel they do have is sitting around waiting for the goods to get off the ships, so they can put them on the trucks and deliver them. That will be a lift to the market when we get that regulated again.

Dean Barber: So hang on, Bud. You said his word was caution. When you say caution, is he cautious over the stock market in general?

Bud Kasper: Yes.

Dean Barber: Does he think that there’s the possibility of a recession on the horizon?

Bud Kasper: He didn’t say anything about that. I think he’s saying in the near term that volatility is interface. The Federal Reserve has a lot to produce to re-regulate the economy.

Buying Our Own Bonds Won’t Keep Working in the Long Run

Let’s face it, we can’t keep buying our own bonds. We know that’s gaming the system. It’s putting demand on the purchase of bonds, which, of course, is raising the prices. That’s good for bond holders, but when they pull that back, which they are going to do, that’s one of the reasons that bonds have been under pressure for the last year or so.

That’s a concern because most investors, especially retirees, turn to bonds for the safety and the income they produce. That’s just one element that they need to deal with. And, of course, the other one is the rising of the rates.

But I do feel that the Federal Reserve will be more measured in how they do that. I’m very not worried about them getting overheated. We’ve got enough history to tell us that it’s better to be slow as we go rather than being fast and getting attacked.

Negative Interest Rates Around the World

Dean Barber: People need to understand what’s happening in the credit markets around the world, not just in the United States. If you look at other major developed countries, Italy, Germany, Japan all are still in a negative interest rate environment with their equivalent of our treasuries. The people there are going to keep buying our treasuries because they’re far more attractive than their own bonds.

Bud Kasper: Exactly right.

Dean Barber: Right now, we’re sitting with a 10-year treasury at about 1.8% or slightly below that. That’s attractive to foreign investors. If they continue to buy at those low interest rates because they have negative interest rates, that’s going to hold that yield down. When the government can’t auction off their bonds at those rates or enough bonds to support the spending that they are doing their deficit spending, suddenly that long-term yield will go up. That’s far different than what the Fed does when they talk about raising rates.

The Fed isn’t going to affect those long-term rates. The market will affect them because of who is buying and how much purchasing is going on. The only thing the Fed really affects is the short-term yield, which is the Fed funds overnight rate or bank-to-bank lending rate.

You could see an era by end of 2022 with a yield curve that is flattened substantially. I don’t think we invert anytime soon, but we would see a flattening of that yield curve if, in fact, the Fed does raise four times this year and we get a Fed funds rate of 1%.

Dean Sticks with His 10-Year Treasury Prediction

At the end of last year, I predicated that we’ll finish 2022 with a 10-year treasury around 2%. I stand by that. I think that there’s so much depressed interest rates internationally that money is still going to flow into our treasuries even if the Fed stops its bond buying program.

Bud Kasper: You’re right on with that. The critical fact is that when we’re buying our own bonds, all we’re doing is adding to our debt. That is a critical issue that has never been addressed by the Federal Reserve, and more importantly by Congress.

At some point, the rubber is going to meet the road with that. We’re fortunate that our interest rates are still attractive to people around the world to do it because they are funding us in terms of how we spend money for the citizens of our country. From that perspective, I think we sometimes lose sight of that.

When you look at Japan, they still haven’t had enough growth to supplant the bond purchases they’ve been using. Their interest rates are incredibly low and are negative at times. It shows how much further ahead we are with our approach to this, but we’re only as good as the people that are willing to buy it.

At the end of every auction that they have in the Treasury, they grade it. Was it a successful auction? If it gets an A rating, it means that they sold all the anticipated paper that they wanted to sell at that time. Or it’s B or C. We don’t want the C’s because we need those people buying our bonds so we can fund our expenses.

There’s Opportunity in Market Volatility

Dean Barber: If I could go out and borrow as much money as I wanted at 1.8% for 10 years, I’d just say, “How much can I borrow?” Because I want it all. I know that I can go out during that 10-year period and make far more than that 1.8%. Therefore, I’m profiting on somebody else’s money. There’s opportunity in volatility. You need to understand where you are, what you hold, why you hold it, and if iit fits within your overall financial plan.

I want to quote one of the most famous investors of all time in Warren Buffet. The quote is, “Be fearful when others are greedy and be greedy when others are fearful.” We’ve been on an absolute wild ride with the markets over the course of the last couple of weeks. This has been one of the worst Januarys in the past couple of decades.

Has the Strong Run of Market Performances Ended?

We had such a good run following the onset of the pandemic, dating back to early April 2020 all the way up through the end of 2021. The markets were seemingly unstoppable. We had a few little hiccups there—a negative 4%, 5% draw down from time to time. But the reality is that we saw markets explode off those COVID lows.

A lot of people are asking if that run is over. Are we now going to give back a lot of those gains? Should we sell out of the market now, take some of our gains, and put them on the sidelines? Should we get out completely and just sit and wait and see what the Fed does this year?

Those questions are almost impossible to answer without a comprehensive financial plan like our Guided Retirement System in place. If you don’t have the plan in place, you will wind up acting strictly on emotion. That’s when bad things can happen.

Let’s go back to the beginning of COVID-19. We saw a 35% drop in the market. At that point, nobody really knew what was going to happen. We were talking about locking down cities and closing schools, restaurants, and everything that wasn’t an essential business. Suddenly, the market drops and goes crazy.

People Are More Fearful Than Greedy Right Now

If a person panicked at that time and sold out at that 35% loss, they’ve probably been fearful to get back in. We’ve had the Delta variant, the Omicron variant and on and on. If you watch the news every day, you’d be scared to death to get back in the market. People are wondering what is going to happen now and have a lot of questions.

  • Were those gains real?
  • Are we going to give those back?
  • Are stocks too overvalued?
  • What is the outlook for growth in the economy?
  • Are these companies going to be able to make it?

I think people are more fearful than greedy, so what does that tell us if we go back to Warren Buffet’s quote. Be greedy when others are fearful.

What’s Going on with Tech Companies?

Bud Kasper: Right. It comes down to earnings. Even tech has taken it right on the chin in January. Tech continues to be under severe pressure, but those companies are earning money that will eventually be re-recognized in the marketplace. I’m not saying run out and get into tech, but it should be part of your portfolio even though it’s suffering right now.

If you look at tech over the last year and you see this most recent decline, it maybe took away maybe 10%, 12, 15% of what the value was at its highest. It’s still a positive return if you’ve had it over the last 12, 16, 24 months.

I think that we’re going to see a return to GARP, which is stands for growth at a reasonable price. That usually comes in from companies that have strong earnings potential associated with them. Higher quality companies are the ones that do well that have that and pay dividends. Remember, even at a falling market, dividends are cashflow. That’s coming back in to mitigate some of the market volatility in and of itself.

An S&P 500 Breakdown

Dean Barber: It’s interesting because Bud and I look at the markets in a different way. We look at whether a market, stock, or sector is bullish, very bullish, neutral, negative—the list goes on. Look at the S&P 500 as an example. Out of the 500 stocks that are in the S&P 500, 55 are rated as bullish, 96 are bearish, and 346 are neutral.

We have much more of a neutral stance on the markets right now. The neutral stance means you should probably just wait a little bit and see what happens. Those 55 bullish stocks will have a hard time carrying the 96 that are bearish.

Understanding What You Own

People need to understand what they own. Oftentimes if somebody owns a mutual fund or an ETF, they don’t really understand what the underlying stocks are that are held within them. That’s exactly what you’re doing when you’re buying an ETF or a mutual fund is you own stocks. What is the makeup of those stocks, though? What stocks do you own? Are those stocks bullish or bearish? Are there areas that you should be looking at where there’s more opportunity? Or are there areas that you should be pulling down your holdings in because there are too many bearish signs?

I think that’s where the sophistication comes in of working with a CERTIFIED FINANCIAL PLANNER™ professional that constructs the entire financial plan. They help break down what your money needs to do and everything that you hold. They go through it with a fine and tooth comb and analyze every single piece. Normally it’s not a complete overhaul of a portfolio, but normally there’s some tactical changes that can be made to reduce risk and improve opportunity for future growth.

Bud Kasper: Dean mentioned that 96 stocks that were negative. If you look at that, what’s going to improve that? The answer is earnings. When they prove that they’re making money again, you’ll see money coming back into it. If it’s paying dividends, you know that you can sit in that stock and allow that to come back if you have conviction that it’s going to come back again. That is a positive.

S&P 500 Has Still Remained Positive Over the Last Year

Look at some of the stocks that embraced the market from the peak of 2021 through January 6. Peloton is down 80%. Zoom is down 60%. DocuSign down about 50%. Goldman Sachs, SPDRs, and IPOs are down, but the S&P 500 through January 6 was still positive during that timeframe.

I think around 30% of return represented in the S&P 500 is from technology. Now that it’s getting beat up, some people are thinking that time is over. But look at what we just saw this past week in earnings. Microsoft was excellent. These companies are printing money and they’re looking into the future. They’re agile enough to continue to move in the direction that their shareholders want them to.

The Main Takeaway: This Isn’t the Time for Guesswork

Dean Barber: The important thing to remember is that this is not a time for guesswork with our current market volatility. This is a time to know exactly what you own, why you own it, and what you expect from what you own.

To avoid doing that guesswork, get a 20-minute ask anything session or schedule a complimentary consultation CERTIFIED FINANCIAL PLANNER™ professional. We can visit you with you by phone, virtually, or in person to dive into your personal situation. In the meantime, make sure to get copies of our 401(k) Survival Guide and Retirement Plan Checklist.

Market volatility is here. The question is, is if this market volatility is here to stay or will it wane? Time is going to tell us that, but right now I think it will wane.

Thank you to everyone who joins us for America’s Wealth Management Show. I’m Dean Barber along with Bud Kasper. Everybody stay healthy, stay safe. We’ll be back with you next week. Same time, same place.

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