By Ivan Sichkar, CFA, FRM, CFP®
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This is the forecast of the S&P 500 Index for 1Q 2023. It is based on the linear regression model, where I use the Gross Domestic Product (GDP) to predict the value of the S&P 500 Index. This forecast tries to predict a general pattern and direction of the stock market in the near future. When the forecast calls for a negative return, it is a warning sign. It means that the S&P 500 Index may be expensive, and equity investors should be extra cautious in the near term. On the other hand, when the forecast calls for a positive return, the S&P 500 Index may be trading at a favorable price level.
Based on the regression results, the S&P 500 index is valued at the 4,620 level for the 1st quarter of 2023. On February 24, 2023, the actual S&P 500 index closed at 3,970.04. If the model is correct, the potential near-term upside is 650 points or 16.36%. The current S&P 500 index remains attractively priced. Equity investors may still find value in today’s stock market if they are willing to weather near-term volatility and hold on to the investment long-term.
This prognosis is based on the expected Gross Domestic Product (GDP) of the United States in nominal terms and current USD terms. I use the GDP to explain the value of the S&P 500 Index. I use the last 10 years of quarterly data for the S&P 500 Index and the GDP to run a linear regression model. I intentionally limit the number of observations to the most recent 10 years. It enables me to focus on the appropriate current structure of the economy. The model continues to change and reflects the ever-changing economic system.
For me to forecast the S&P 500 index for the 1st quarter of 2023, I have to calculate an estimated GDP for the 1st quarter of 2023 as well. According to the economic projections of the Federal Reserve Bank Board Members and Federal Reserve Bank Presidents released on December 14th, 2022, the real GDP is expected to increase between 0.4% and 1.0%, and Personal Consumption Expenditure is expected to increase between 2.9% and 3.5% for the year 2023. As a result, the nominal GDP is estimated to rise between 3.3% and 4.5%. Next, I divide the annual expected GDP growth by 4 to calculate the 1Q 2023 GDP number.
By multiplying the current dollar GDP for Q4 2022 by the expected nominal change for the 1st quarter of 2023, I calculate the GDP for the 1st quarter of 2023 to be between $26,360 and $26,439 billion. Next, I can forecast where the S&P 500 Index will close at the end of the 1st quarter of 2023. I am using the Excel spreadsheet to run a linear regression model where the S&P 500 is a dependent variable, and GDP is the independent variable. Based on the last ten years of quarterly data, I forecast the S&P 500 Index to close between 4,608 and 4,631 at the end of the 1st quarter of 2023 (see Table 1). The midpoint for the S&P 500 index is forecasted to be at 4,620 during the 1st quarter of 2023.
Summary statistics show that the GDP can explain 84% of performance in the S&P 500 Index (see Table 2). The overall regression model looks appropriate to be used in the S&P500 forecast since the Significance F is very small, near zero. It means there is a very small chance that the results are based on random luck. Also, the P-value of the intercept and the independent variable (GDP) is very small, near zero. This means that the GDP is statistically significant in explaining the performance of the S&P 500 Index. Also, the best-fit line shows how close the predicted values are to the actual S&P500 index (see Chart 1).
The S&P 500 forecast for the first quarter of 2023 shows that the index may still have about a 16.36% upside remaining from February 24, 2023 close price. The S&P 500 index is valued at 4,620. The S&P 500 index appears to be attractively priced at this level. Equity investors who purchase the S&P500 index may have a fair chance to be compensated for the risk taken. As always, this forecast, as well as any other prediction model is not perfect. This model can be used as one of the tools to help measure how expensive or discounted the stock market is near term. As practice has shown, markets can be volatile, surprising, and irrational.
Data:
The Federal Reserve Bank, retrieved on Februart 26, 2023
https://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20221214.pdf
U.S. Bureau of Economic Analysis, Gross Domestic Product [GDP], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/GDP, February 25, 2023.
Yahoo! Finance, S&P 500 index data, retrieved from https://finance.yahoo.com/, February 25, 2023.
Disclosures:
The analysis is based on historical data and future expectations that may not be correct. This paper was written as an opinion only. The data is not guaranteed to be accurate or complete. Please consult with your financial advisor, before making an investment decision. Neither ECNFIN.COM nor its author is responsible for any damages or losses arising from any use of this information. Past performance doesn’t guarantee future results.
ECNFIN.com and its podcast are not associated with nor do they necessarily represent the opinion or advice of Epiqwest Culver Wealth Advisors LLC.
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It is a combination of multiple negative factors that creates a worrisome diagnosis for already fragile economic health of the US economy. A sharp increase in oil prices from $22 in April 2020 to $120 in June 2022. The highest inflation since 1981 which is likely to stay elevated for a while. The Fed which found itself behind in raising rates and has a catch up to do to preserve its credibility. The US consumers who are experiencing a decline in real wages, increase in debt, and a decline in savings. About 70% of the Gross Domestic Product is explained by the consumer spending. With falling disposable income, the GDP is likely to decline as well. All these negative factors combined create a possible case scenario for the economic recession in the near term. This economic recession may be caused by a sharp decline in consumer spending which will also lessen inflationary pressures.
Today’s oil price is at $120 up from just $22 in 2020. Nonlinear models of using net oil price increase to explain the US recessions may explain as high as 5 percent decline in the US real GDP according to Kilian and Vigfusson (2014). The conditional regression model becomes even more effective when combined with a restrictive monetary policies and high inflation during Paul Volcker time and the global financial crisis of 2008 according to Kilian and Vigfusson (2014).
The recession does not always follow the increase in oil prices. Since 1974 there were eight episodes of net oil price increases and only five were followed by recessions based on Kilian and Vigfusson (2014). There is also no exact timing for predicting a recession. Some recessions happened few months after the increase in net oil price. Other recessions happened at the same time of the increase in oil prices (see Chart 1). On its own the increase in oil prices may not be the sole cause of a recession. However, when we start adding extra negative economic forces, the risk for a recession may increase significantly.
Current inflation in the US has increased the most since the 1981 based on the Consumer Price Index. This index increased by 8.6% for the 12 months ending May 2022 according to the U.S. Bureau of Labor Statistics. Some items saw the record price increases. Fuel oil more than doubled in price over the last 12 months, rising 106.7% (see Chart 2). It was the largest increase in the history of the series, since 1935, according to the U.S. Bureau of Labor Statistics. Food at home also saw a record increase by 11.9% over the last 12 months. It was the largest increase since 1979. Inflating is proving to be more sticky than transitory. Prolonged war in Ukraine with no near horizon solution is likely to keep a supply driven inflation high for commodities and agricultural products for a while. I have also described a supply driven inflation in my prior article as of March 2022. You can read my full article by clicking on this link: https://ecnfin.com/2022/03/21/economic-recession-maybe-around-the-corner-in-the-us-and-europe/
Russia is a major supplier of nickel, major exporter of oil, natural gas, coal and the world’s biggest exporter of wheat and fertilizer products. Ukraine is also one of the biggest exporters of wheat and agricultural products. Since the US oil production does not increase and the supply disruption of other commodities and agricultural products are likely to be long-term, the inflationary pressure may persist.
The Federal Reserve has a dual mandate: low and stable inflation at the rate of two percent and maximum employment level according the Bord of Governors of the Federal Reserve System (2022). The current unemployment rate is at 3.6% (see Chart 3). The 3.6% unemployment rate is one of the lowest numbers since 1970s and gives the Fed plenty of room to raise rates. The Fed has its reputation to safeguard and a dual mandate to focus on. To fight the inflation, the Fed will need to orchestrate economic slowdown and increase unemployment. As you can see from the Chart 3, unemployment increased during all economic recessions. The Fed will try do its best to do a soft landing – slow down the economy without causing a recession. However, soft landing would be very difficult to do given the Fed is already behind the curve and is facing a continuous increase in inflation. You may think of the current Fed as a student with all C grades during the semester who is now trying to pull an A grade during the final exam. It is statistically possible but highly unlikely. Adding an additional analogy of the Federal Government as a parent who did not invest time and money into the education system and instead gave one-time gifts to the student. Both the student and the parent will have a very difficult and painful time trying to change. The student may still be able to pass the class but receiving an A grade looks very unlikely.
The Fed has couple of tools in its possession to slowdown the economy. The first and the most used tool is the target interest rate set by the Federal Open Market Committee. This rate is also called the federal funds rate. On May 4th, 2022, the Fed increased its target range for the federal funds rate to 0.75%-1% according to the Federal Reserve (May 4, 2022). The Fed is expected to continue interest rate increases as inflation persists.
The second tool is the Fed’s balance sheet. By reducing the holdings of securities on its balance sheet, the Fed will decrease the amount of money available in the system. The current Fed’s balance sheet has about $8.5 trillion worth of securities held according to the Federal Reserve (June 9, 2022). The Fed holds the US treasury securities of different maturities from short-term to long-term (see Chart 4). According to the Federal Reserve, it will reduce its balance sheet by not reinvesting the proceeds from the principal and interest payments received. For the US treasuries the decline in holdings will be in the amount of $30 billion per month from June 1, 2022 and $60 billion per month after September 1st, 2022. For the agency debt and mortgage-backed securities the decline will be $17.5 billion per month from June 1, 2022, and $35 billion per month after September 1st, 2022. By looking at the maturity distribution of the current balance sheet you may notice that the Fed has enough US treasury bonds maturing on time to meet the scheduled reductions by the Fed. So, the Fed will keep the money received from maturing debt principle without buying or selling additional US treasury securities. In contrast, mortgage debt securities held by the Fed have much longer maturity schedule. So, the Fed may have to sell mortgage-backed securities.
The current main goal of the Fed is to slow down the demand-pull inflationary pressures. By raising its interest rate and shrinking its balance sheet, the Fed is trying to slowdown the consumers’ demand. Consumer spending accounts for about 70% of the Gross Domestic Product in the US. Even before the Fed’s more restrictive monetary policies, some consumers were already feeling priced out. The increase in wages does not fully compensate for the increase in the inflation. As the result, consumers now have less purchasing power than before. For example, the real weekly earnings declined from $393 during the 2nd quarter 2020 to $363 during the 4th quarter 2021 (see Chart 5). This represents the 8% decline is the real purchasing power.
The decline in the personal savings rate also supports the view that the US consumer is already feeling financially stretched. The personal savings rate has already declined to 4.4% which is the lowest level since the global financial crisis of 2007-2008 (See Chart 6). The Fed just started raising rates, and the inflation is likely to stay elevated much longer. With rising interest rates and elevated inflation, there is no relief for the consumer in the near term.
Consumers’ debt levels on credit cards and other revolving plans have increased to the new historical record level. As of June 2022, the consumer loans balance was $868 billion (see Chart 7). Consumer credit card loan payments increase with the increase in interest rates. As rates increase, consumers’ interest expense may increase further causing a further decline in the disposable income.
Similarly, corporations have also increased its debt levels to the historical record. As of June 2022, non-financial corporations borrowed $12,169 billion (see Chart 8). High debt levels help during the good times and hurt during the bad times. A possible economic recession may decrease corporate revenues caused further decline in profitability of a more leveraged companies. The decrease in corporate profits may also hinder the ability of companies to meet its debt obligations.
Combination of the above-described factors: high oil prices, persistent inflation, high consumers’ and corporate debt balances, and restrictive monetary policies create a case scenario for a possible economic recession. One possible outcome from this recession can be a decline in consumer and business spending, which will increase unemployment and decrease the demand for goods and services. If this scenario plays out, the inflationary pressures will fade at the cost of the recession.
Disclosures:
The analysis is based on historical data and future expectations that may not be correct. This paper was written as an opinion only. The data is not guaranteed to be accurate or complete. Please consult with your financial advisor, before making an investment decision. Neither ECNFIN.COM nor its author are responsible for any damages or losses arising from any use of this information. Past performance doesn’t guarantee future results.
ECNFIN.com and its podcast are not associated with nor do they necessarily represent the opinion or advice of Epiqwest Culver Wealth Advisors LLC.
Sources:
Bord of Governors of the Federal Reserve System 2022. https://www.federalreserve.gov/monetarypolicy/monetary-policy-what-are-its-goals-how-does-it-work.htm
Board of Governors of the Federal Reserve System (US), Consumer Loans: Credit Cards and Other Revolving Plans, All Commercial Banks [CCLACBW027SBOG], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/CCLACBW027SBOG, June 11, 2022.
Board of Governors of the Federal Reserve System (US), Nonfinancial Corporate Business; Debt Securities and Loans; Liability, Level [BCNSDODNS], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/BCNSDODNS, June 12, 2022.
Federal Reserve statistical release June 9, 2022. https://www.federalreserve.gov/releases/h41/current/h41.pdf
Federal Reserve issues FOMC statement, May 4, 2022. https://www.federalreserve.gov/newsevents/pressreleases/monetary20220504a.htm
Lutz Kilian and Robert J. Vigfusson “The Role of Oil Price Shocks in Causing U.S. Recessions” Board of Governors of the Federal Reserve System August 2014 https://www.federalreserve.gov/pubs/ifdp/2014/1114/ifdp1114.pdf
Macrotrends data retrieved on June 12, 2022. https://www.macrotrends.net/1369/crude-oil-price-history-chart
Plans for Reducing the Size of the Federal Reserve’s Balance Sheet. May 4, 2022. https://www.federalreserve.gov/newsevents/pressreleases/monetary20220504b.htm
U.S. Bureau of Labor Statistics, Unemployment Rate [UNRATE], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/UNRATE, June 12, 2022.
U.S. Bureau of Labor Statistics, Employed full time: Median usual weekly real earnings: Wage and salary workers: 16 years and over [LES1252881600Q], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/LES1252881600Q, June 12, 2022.
U.S. Bureau of Economic Analysis, Personal Saving Rate [PSAVERT], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/PSAVERT, June 12, 2022.
U.S. Bureau of Labor Statistics. Consumer Price Index Summary. June 10, 2022. https://www.bls.gov/news.release/cpi.nr0.htm
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Inflationary pressures are becoming less transitory and more long-lasting. Even before the horrific events in Ukraine, inflation was already very high. Additional sanctions on Russia added additional fuel to the fire of already hot inflation. Sanctions on Russia will also have a significant negative economic effect on the world economy and particularly Europe. My heart and worry are with Ukrainians and everybody effected by the war. The world came together to punish Russia economically. However, it is not a one-party loss. Europe and the US will feel the pain from fighting an economic war with Russia. In addition, any resurgence of Covid-19 and potential new variants may further disrupt the supply chain and put pressure on both economic growth and higher inflation. The Federal Reserve found itself behind the curve in raising rates. In my opinion, the Fed may have to increase its short-term interest rate significantly and faster than many may have hoped for. Combination of all these factors makes the recession in the US and Europe more likely withing the next 12 months.
Today’s world has two bipolar images of pain and suffering in Ukraine as one image and reopening of the economy in the US and Europe as the second image. It is difficult to comprehend that both images could coexist at the same time. Pent-up demand after the Covid-19 pandemic may drive prices higher. People are craving travel, going out, and experiences. The increase in the demand for travel will add upper pressure on energy prices. By going out to restaurants, watching shows, attending sporting events and concerts, the demand for food and labor may increase further. Greater demand for goods and services in combination with already tight labor market, may translate into higher wages. Employers may have to pay higher wages to attract employees.
Low unemployment and strong economy may create a favorable environment for wage growth. The current labor market can be described as tight and near full employment. Unemployment rate has declined from 14.7% in April 2020 to 3.8% in March 2022 (see Chart 1 Unemployment Rate). When the labor market is tight, employers will have to raise wages to attract new employees. During periods of strong economic growth and increasing demand for goods and services, employers can pass the increase in labor cost to consumers. In some cases, prices may rise faster than the increase in wages. In this case, employees will demand another increase in salary. This chain reaction may continue to trigger additional increase in prices followed by higher wages.
Possible further increase in oil prices may boost overall U.S. inflation. The Fed Chairman Jerome Powell said that $10-per-barrel increase in oil prices may increase the inflation by 0.2% in the US (WSJ Inflation). Crude oil has already increase by $40 since the beginning of 2022 which may have contributed to 0.8% increase in the overall inflation during the first two months in 2022. Russia has predicted the price of oil above $300 if the West bans energy imports (CNBC Russia). If we see oil prices rise above $300, the overall inflation may increase by more than 4% from 7.9% currently to 12% per year.
The supply driven inflation may continue for longer than the Fed has expected. As the war in Ukraine continues, the economic sanctions on Russia may continue to escalate. Russia is a major supplier of nickel. The shortages of nickel may drive the cost and disruptions in the production of electrical vehicles and stainless steel. Nickel in used in the production of batteries and stainless steel. Russia is also a major exporter of oil, natural gas, coal and the world’s biggest exporter of wheat and fertilizer products. Ukraine is also one of the biggest exporters of wheat and agricultural products. As Europe and the US cannot buying commodities and agricultural products from Russia and Ukraine, the inflationary pressure will persist.
Another disruption in the supply chain can come in from China and its zero-tolerance policy for Covid-19 outbreaks. China shuts down factories and implements strict quarantine with each Covid-19 outbreak. Also, there is a possibility of a new variant to appear and disrupt the supply chain unexpectedly.
The Federal Reserve has a dual mandate: maximum employment and stable prices. We are already near full employment (See Chart 1). The Fed should focus on its second goal now – stable prices. The most recent total CPI index increased by 7.9% over the last 12 months (see Chart 2). The biggest increases in prices over the last 12 months were in Fuel Oil 43%; used cars 41%; gasoline 38%; energy commodities 37%. The Fed has a long-term inflation target of 2%. By drawing the 2% inflation target next to the actual price changes over the last 12 months, you can clearly see a very significant spike in inflation and a wide deviation from the two percent target (see Chart 2.)
The Fed was already behind the curve in raising interest rates. The inflationary pressures may accelerate further this year and remain long-lasting. On March 16th, the Fed raised its benchmark federal-funds rate by 25 bps to the range of 0.25%-0.50%. The Fed has also signaled six more increases by the end of the year (WSJ, Fed Raises Interest Rate.). The median projections by the Federal Reserve Board members is 1.9% by the end of 2022 and 2.8% by the year end 2023 (Board of Governors). In my opinion, the Fed may start raising interest rates faster than the consensus expectations. The Fed may consider even 50bps increases instead of tradition 25bps. As the President of the Federal Reserve Bank of St. Louis, James Bullard said that the Fed should raise rates faster or “risk squandering policy credibility” (WSJ, Fed Raises Interest Rates). This is what the stock market is not pricing in right now. The short-term yield is likely to go much higher this year. As the Fed pushes the short-term yields higher, the yield curve may start to flatten and even reverse at some point.
As the Fed raises its short-term rates, the long-term rates may not move up in the same proportion. Investors may find long-term treasury bonds as an attractive hedge against a recession. As the Fed is trying to cool down high and increasing inflation by raising short-term interest rates and slowing down the economy, the Fed may over tighten. The current interest rate spread between 10-Year Treasury and 3-month Treasury is 1.80% as of March 17, 2022 (Chart 3). So, there is still plenty of room before the yield curve becomes inverted. However, with each increase in the short-term rates the yield curve may become flatter and finally invert in the near future. This may signal the risk of the economic recession and create the demand for long-term treasury bonds.
An inverted yield curve has always been a strong predictor of the economic recessions in the US. It predicted economic recessions of 1990-1991; 2001; 2008-2009 and the most recent Covid-19 recession in 2020 (see Chart 3). Currently high and rising inflationary pressures, may cause the Fed to raise short-term rates significantly higher and above the long-term treasury yield. This will create an inverted yield curve, a strong indicator of a possible economic recession.
In addition to high inflation and restrictive monetary policies, the sanctions against Russia and horrific events in Ukraine slow economic growth in Europe and the US. The sanctions against Russia will have a significant negative economic impact on Europe and even the US. This is the economic pain which Main Street will feel. Russia’s total export and import with non-CIS countries was at $700 billion in 2021 and $100 billion with CIS countries (see Chart 4). CIS countries include Azerbaijan, Armenia, Belarus, Kazakhstan, Kyrgyzstan, Moldova, Russia, Tajikistan, Turkmenistan, Uzbekistan and Ukraine. You can see the significant economic ties between Russia and the West. The production and movement of goods together with the banking system has a multiplier effect. The sanctions against Russia will both increase inflation and slowdown economic growth across the Europe and the US.
As the forecast for the year 2022, I would expect high and long-lasting inflationary pressures to persist. The Fed may be more hawkish and willing to raise rates significantly to fight inflation and keep its credibility. The European Union and to a lesser degree the US economy will lose growth as a result of the economic fight with Russia. Zero tolerance policy against Covid-19 outbreaks in China will continue to disrupt the supply chain and put inflationary pressures. In combination, higher interest rates and lower economic growth increase a risk for the next recession.
Disclosures:
The analysis is based on historical data and future expectations that may not be correct. This paper was written as an opinion only. The data is not guaranteed to be accurate or complete. Please consult with your financial advisor, before making an investment decision. Neither ECNFIN.COM nor its author are responsible for any damages or losses arising from any use of this information. Past performance doesn’t guarantee future results.
ECNFIN.com and its podcast are not associated with nor do they necessarily represent the opinion or advice of Epiqwest Culver Wealth Advisors LLC.
References:
BOARD OF GOVERNORS of the FEDERAL RESERVE SYSTEM. Retrieved on March 17, 2022. https://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20220316.pdf
CNBC EUROPE NEWS. Russia warns of $300 oil, threatens to cut off European gas if West bans energy imports https://www.cnbc.com/2022/03/08/russia-warns-of-300-oil-if-ban-goes-ahead-threatens-to-cut-off-european-gas.html
Federal Reserve Bank of St. Louis, 10-Year Treasury Constant Maturity Minus 3-Month Treasury Constant Maturity [T10Y3M], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/T10Y3M, March 10, 2022.
Merchandise Trade of the Russian Federation, Bank of Russia. https://www.cbr.ru/eng/statistics/macro_itm/svs/ March 5, 2022
U.S. Bureau of Labor Statistics, Unemployment Rate [UNRATE], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/UNRATE, March 9, 2022.
U.S. Bureau of Labor Statistics, Consumer Price Index Summary https://www.bls.gov/news.release/cpi.nr0.htm , March 10, 2022
WSJ. Inflation Reached 7.9% in February; Consumer Prices Are the Highest in 40 Years https://www.wsj.com/articles/us-inflation-consumer-price-index-february-2022-11646857681?mod=hp_lead_pos1&mod=hp_lead_pos1
WSJ. Fed Raises Interest Rates for First Time Since 2018. https://www.wsj.com/articles/fed-raises-interest-rates-for-first-time-since-2018-11647453603
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This is the forecast of the S&P 500 Index for the 1Q 2022. It is based on the linear regression model where I use the Gross Domestic Product (GDP) to predict the value of the S&P 500 Index. This forecast is trying to predict a general pattern, direction, of the stock market in the near future. When the forecast calls for a negative return, it is a warning sign. It means that the S&P 500 Index maybe expensive and equity investors should be extra cautious in the near term. On the other hand, when the forecast calls for a positive return, it means that the S&P500 Index maybe trading at favorable price level.
Based on the regression results, the S&P 500 index is valued at 4,513 level for the 1st quarter 2022. On February 4, 2022, the actual S&P 500 index closed at 4,500. If the model is correct, the potential near term upside is only 13 points or 0.29%. The current S&P 500 index looks fairly priced. Another way to interpret the forecast results is to think of today’s S&P 500 index level as having limited upside potential near term. Equity investors may not be compensated for taking equity risk near term.
This prognosis is based on the expected Gross Domestic Product (GDP) of the United States in nominal terms, current USD terms. I use the GDP to explain the value of the S&P 500 Index. I use the last 10 years of quarterly data for both the S&P 500 Index and the GDP to run a linear regression model. I intentionally limit the number of observations to the most recent 10 years. It enables me to focus on the appropriate current structure of the economy. The model continues to change and reflects ever-changing economic structure.
For me to forecast the S&P 500 index for the 1st quarter 2022 I have to calculate an estimated GDP for the 1st quarter 2022 as well. According to the economic projections of the Federal Reserve Bank Board Members and Federal Reserve Bank Presidents released on December 15th, 2021, the real GDP is expected to increase between 3.2% and 4.6%, and Personal Consumption Expenditure is expected to increase between 2.0% and 3.2% for the year 2022. As a result, the nominal GDP is estimated to rise between 5.2% and 7.8%. Next, I divide the annual expected GDP growth by 4 to calculate the 1Q 2022 GDP number.
By multiplying the current dollar GDP for 2021 by the expected nominal change for the 1st quarter 2022, I calculate the GDP for the 1st quarter 2022 to be between $24,304.26 and $24,460.21 billion. Next, I can forecast where the S&P 500 Index will close at the end of the 1st quarter 2022. I am using the Excel spreadsheet to run a linear regression model where the S&P 500 is a dependent variable, and GDP is the independent variable. Based on the last 10 years of quarterly data, I forecast the S&P 500 Index to close between 4,483 and 4,543 at the end of the 1st quarter 2022 (see Table 1). The midpoint for the S&P 500 index is forecasted to be at 4,513 during the 1st quarter 2022.
Summary statistics shows that the GDP can explain 90% of the performance in the S&P 500 Index (see Table 2). Overall regression model looks appropriate to be used in the S&P500 forecast since the Significance F is very small near 0. This means there is a very small chance that the results are based on a random luck. Also, the P-values of the intercept and the independent variable – GDP are very small, near 0. This means that the GDP is statistically significant in explaining the performance of the S&P 500 Index. Also, the best fit line shows how close the predicted values are to the actual S&P500 index (see Chart 1).
The S&P 500 index forecast for the first quarter 2022 shows that the index maybe fairly priced with just 0.29% upside remaining from the February 5th close price. The value of the S&P 500 index is projected to be at 4,513 at the end of the 1st quarter 2022. The S&P 500 index appears to be fairly priced. Equity investors who purchase the S&P500 index may not be compensated for the risk taken in the near term. This model can be used as one of the tools to help measure how expensive or discounted the stock market is near term. As with all forecast models, it is not perfect and may not always provide the correct forecast. This forecast should not be the only evaluation tool used. Instead, it should be one of many diagnostic tools in the evaluation toolbox of investors.
Data:
The Federal Reserve Bank, retrieved on February 5th, 2022
https://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20211215.pdf
U.S. Bureau of Economic Analysis, Gross Domestic Product [GDP], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/GDP, February 5, 2022.
Yahoo! Finance, S&P 500 index data, retrieved from https://finance.yahoo.com/, February 5, 2022.
Disclosures:
The analysis is based on historical data and future expectations that may not be correct. This paper was written as an opinion only. The data is not guaranteed to be accurate or complete. Please consult with your financial advisor, before making an investment decision. Neither ECNFIN.COM nor its author are responsible for any damages or losses arising from any use of this information. Past performance doesn’t guarantee future results.
ECNFIN.com and its podcast are not associated with nor do they necessarily represent the opinion or advice of Epiqwest Culver Wealth Advisors LLC.
Subscribe wherever you enjoy podcasts:
Our Mailing Address:
ECNFIN
1312 17th Street
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Investing Principle # 1: Why should you invest? By investing today, you invest in your future with the hope of a better quality of life.
When you invest today, you may earn a future reward which you can then enjoy later on. It is prudent to balance the future reward with today’s pleasure. Spend some of your monthly budget on pleasure today, but also save some of your money and invest in your future. It is good to have a healthy balance. In contrast, when you use a credit card to receive a joy today, you borrow against your future. You will have to work more to pay back your credit card balance in the future. Instead of borrowing against your future time, you should start investing in yourself. You will feel better each month knowing that in the future you may have more free time and ability to enjoy a better quality of life. Invest in yourself starting today.
Investing Principle # 2: Investing has become more accessible than before. Commission free trading provided access to financial markets for investors of all sizes, it created a greater opportunity to profit even for small investors.
Before, investing was more accessible to wealthy individuals. Wealthy people own most of the stock market and their wealth increases over time widening the inequality gap. The richest one per cent of Americans own more stocks than half of the US households, according to the Goldman Sachs (Financial Times). Also, the top one per cent of Americans own 31% of all household wealth. In contrast, the bottom 50% of Americans own only 2% of household wealth according to the Federal Reserve (see Chart 1). Available access to investing should improve inequality and create opportunities for investors of all sizes. All investors have an opportunity to increase their wealth and enjoy a better quality of life.
Recent advances in the financial world provided opportunities for everybody to become an investor. There is no minimum account balance required. With as little as $100 you can become an investor today. That is a low barrier to enter. A while back, mostly wealthy individuals could benefit from the stock market. Wealthy people became even wealthier by investing (see Chart 1). It is important to know about today’s opportunities and how you can benefit from investing.
One of the major recent improvements in the financial system is commission free trading for US stocks, ETFs, and options. That is a huge benefit for the beginner investors. It allows low barrier to enter. In 2015, Robinhood started offering commission free trading. Later, in 2019, Charles Schwab began offering commission-free online trading. Soon after, the rest of the major financial institutions started offering zero trading costs in the US. Today, you can open a brokerage account at TD Ameritrade, Fidelity, Charles Schwab or Robinhood and pay zero trading costs.
Why is zero commission so important for the beginner investor with little money to invest? Before, companies like Charles Schwab charged $4.95 per trade or TD Ameritrade used to charge $9.95 per trade. Trading fees are the negative drag on your investment returns. Let’s assume you have $1000 to invest and you decide to buy ten securities. If you had to pay $9.95 per trade, you would have spent $95.50 to purchase ten securities. Similarly, it will cost you another $95.50 to sell these ten securities. The round-trip investment would have costed you $191. That is equivalent to the 19% of your total portfolio value. From the start, you had to recoup $191 or 19% just to break even. Before zero commission trading era, small investors could not afford to buy and sell individual securities without falling behind in performance. Smaller investors were at disadvantage. However, everything changed now. Now, all investors regardless of their size have an opportunity to participate in the stock market.
Investing Principle # 3: Open the right type of the investment account for your needs.
Selecting the right type of the investment account may improve your after-tax investment returns. Most of the time you will have to select between taxable, tax exempt or tax deferred account types. In many cases you may need to have both taxable and non-taxable accounts. What are the benefits of taxable and non-taxable accounts? This is a very brief description of just a few available options. For better understanding, you should consult with your accountant or financial advisor to determine which account type meets your needs.
A taxable account can be Individual or Joint account. With a taxable account you share the tax risk with the IRS. Capital and incomes gains are your tax liability – IRS gains. In contrast, capital losses are your tax deductions – IRS losses. It might be prudent to have growth stocks with no dividends in your taxable account. When you have realized capital losses you may be able to deduct them on your tax returns. Another benefit of a taxable account is flexibility. There are no penalties for early distributions or limits for deposits. Taxable accounts give you the most flexibility, but they are typically more expensive. All your contributions are after tax and you are required to pay tax on all realized capital gains and income every year.
Tax advantaged accounts are your 401k Retirement Plans, Regular IRA and Roth IRA accounts. Tax advantaged account are more tax efficient and may improve your investment returns. However, they come with more restrictions.
If you work for a company that offers a 401k retirement plan, you have access to a tax deferred account. A 401k plan lets you grow your investments in a tax deferred environment. You will not pay any capital or income tax while money stays in the account. Also, you may be able to contribute much more to the 401k plan than you can to the Individual Retirement Account (IRA). All your contributions are before tax. In the year 2021, you are allowed to contribute up to $19,500 in a 401k plan. If you are at least 50 years old, you are allowed an additional $6,500 catch-up contribution. Some employers offer a 401k match where the employer will match your contributions based on the specific formula. If your employer offers a 401k match it is like extra bonus available to you. You can make extra money by simply selecting to contribute to a 401k plan. You may want to contribute at least up to the full match, so you do not leave money on the table. The 401k plan is designed to save for retirement, so it might be difficult to take early distributions. Also, early distributions maybe subject to penalties.
An Individual Retirement Account (IRA) Regular or Roth are tax-advantaged accounts. If your tax level does not change over time, both Regular IRA and Roth IRA accounts should have the same tax benefit. With the Regular IRA account, contributions are tax deductible if your income is below the IRS guidelines. You will pay tax when you take distributions from the Regular IRA. In contrast, the Roth IRA works the opposite from the Regular IRA. With the Roth IRA account, your contributions are after tax, and distributions are tax exempt. All capital gains and income are non-taxable in both Regular and Roth IRA accounts. In 2021, you can contribute maximum of $6,000 or $7,000 if you are 50 or older (IRS) to the Regular IRA or Roth IRA account or both. The total combined contribution cannot exceed the maximum $6,000 or $7,000 if you are 50 years old or older. If you decide to take money out from your IRA account early, you may be subject to early distribution penalties.
Having both taxable account and tax advantage account are smart strategies for beginner investor. Taxable account will give you the most flexibility. Whereas, the tax advantaged accounts help each earned dollar to go further, and have better investment returns.
Investing Principle # 4: Smart cash management may decrease risk and increase return for investors.
Investors should have cash savings in their bank account for cloudy days. Cash savings may hedge the unknown need for cash distributions in the future (Ivan Sichkar, 2012). It is a smart risk management technique which may also improve the overall investment return. Unexpected need for cash increases during economic downturns. There is a greater probability of a job loss and prolonged unemployment during an economic downturn. Without enough cash savings, the investor may start to withdraw money from the investment portfolio. Economic downturn is the least favorable time to sell securities. You will be selling securities when the prices are low. By selling securities when the prices are down will prevent the investor from participating in the future stock market recovery. In contrast, smart cash management may provide necessary cushion for investors to weather the economic hardship and wait for the financial markets to recover. Instead of relying on the investment portfolio, investors should have at least 6-month worth of living expenses saved as cash.
Investing Principle # 5: Patience may help pay off in the long run.
You should allow enough time for your investment strategy to become successful. Assuming your original investment thesis was correct, the more investors wait and not react on news the better performance results maybe. However, it is important to distinguish between patience and pride. Sometimes, it’s important to realize that we all make mistakes and to cut your losses. We are all subject to behavioral biases which are very difficult to control. Investors are subject to loss aversion and are likely to sell positions when prices are down in order to limit their losses. Loss aversion expresses the intuition that a loss of $X is more aversive than a gain of $X is attractive (Daniel Kahneman and Amos Tversky, 1984). Representativeness heuristic explains how investors base their predictions on descriptions and recent data instead of personal beliefs and fundamental analysis. By watching CNBC and Bloomberg, investors may rely on incomplete analysis and make decisions that are not based on comprehensive fundamental research. Be patient with your investment decisions. Take your time to do research and make decisions based on your homework results.
Investing Principle # 6: Start early and contribute regularly to your investment portfolio.
You can open the investment account with $100 today. Regular contributions may improve your investment returns. Also, time helps your portfolio to grow substantially. Early small contributions may have the same overall result as large but late contributions would. For example, John opens the investment account at age 18 with $100 initial deposit. He contributes $100 per month for the next 32 years until he is 50 years old. Let’s assume John puts all of his money in the S&P 500 Index which represents the large cap US companies. The annualized total return for this index was 13.5% during the last 10 years. Let’s assume John was able to earn 13.5% on his investment between age 18 and 50. At age 50, John should have $650,867 in his portfolio (see Table 1 and Chart 1). You should know that the actual future return will be different from the assumed performance in this example. The actual return will be lower or higher depending on the future market performance.
Let’s compare John who started investing early with Bob who procrastinated. By waiting to invest later, Bob had to contribute many times more each month in order to catch up to John and to have a similar portfolio value at age 50. Bob waited till he was 30 years old to start contributing. He had to contribute $530 each month in order to have the portfolio value of $651,169 when he turned 50 years old (see Table 1 and Chart 2). It is much more difficult to contribute $530 each month than to contribute $100 per month. By starting your investment contributions early, it is much easier to contribute smaller amounts which may grow into a good size portfolio in the future. As a reminder, your actual future return will be different from the assumed performance in this example. The actual return will be lower or higher depending on the future market performance.
Investing Principle # 7: How investment returns may improve your quality of life?
By now you know, what it takes to earn a good size portfolio over time. What can you do with $650,000? You may be able to use this portfolio to supplement your regular salary or completely live off your investments. Let’s assume John will live till age 100 and decided to live off his portfolio. If he can achieve the 13.5% annualized return, John will be able to take $7,331.00 per month from his portfolio for the next 50 years (see Chart 2). The assumptions are based on annualized 13.5% return which you may or may not be able to achieve in the future. It is still very attractive to see visually how $100 contributions may result in $650,000 portfolio value. The investor may then be able to use the $650,000 portfolio to withdraw $7,331.00 each month for the rest of his or her life (see Chart 2). The performance results in this example are based on the assumptions. In the real life the performance will be lower or higher based on the market conditions.
Investing Principle # 8: Understand your risk tolerance before you invest.
The first step is to realize your true risk tolerance before investing. How much risk can you tolerate in theory and in practice? It is easy to fall a victim of being a risk taker on paper but realize risk aversion in reality. When the stock market enters a correction territory by falling more than 10%, the feeling of anxiety may cause you to fall a victim of the loss aversion bias. Loss aversion expresses the intuition that a loss of $X is more aversive than a gain of $X is attractive (Daniel Kahneman and Amos Tversky, 1984). It will be the least favorable time to make changes to your portfolio when the prices are down. If you are feeling difficulty to remain calm and rational during volatile times or simply are against taking too much risk with your savings, you should have a diversified portfolio. The simple 50/50 asset allocation which comprises of 50% iShares Core S&P 500 ETF (IVV) and 50% iShares 20+ Year Treasury Bond ETF (TLT) is one example of a simple diversification strategy. A risk averse investor may still benefit from the financial markets by having a diversified portfolio which lowers the volatility. Lower volatility will make you feel more comfortable to stay invested through ups and downs.
In addition to a diversified portfolio, a risk averse investor should also use regular rebalancing. Periodic rebalancing is additional risk management took. Rebalancing is bringing out of balance securities in your portfolio in line with the original target allocation. In order to rebalance you would sell overweight securities and buy underweight securities to bring overall allocation in line with your original target. You should rebalance regularly, at least monthly. The advantages of rebalancing are that you will be selling high and buying low. This strategy will limit your risk by trimming gainers and not letting one security to become a large single risk factor in your portfolio. The downside of rebalancing is tax implications. If you have a taxable account, every time you sell the appreciated stock, you will own tax to the IRS. However, if you have a tax-deferred or a tax-exempt account, such as IRA, Roth IRA, 401k, Roth 401k, capital and income gains are tax exempt. You will pay tax from future cash distributions.
Investing Principle # 9: Diversification may lower volatility and help you achieve your financial goals.
A diversified portfolio can create a more comfortable environment for investors to weather the stock market ups and downs. A well-diversified portfolio will have a lower risk with a potential upside for investors. Investors are more likely to stay the course and remain invested when their portfolio volatility is within their comfort zone. The goal is always to be invested during ups and downs. For example, a diversified portfolio which captures 50% of the down market and 60% of the up market may ease the anxiety of a risk averse investor. There is a greater probability for a risk averse investor to stay invested during all market conditions with a lower volatility portfolio. At the end, slow but steady wins the race to the financial goal.
There are many ways to diversify. One simple solution that may work is to combine asset classes that behave differently in relation to each other when the stock market declines. I find the US Government long-term bonds tend to provide a valuable benefit of a negative correlation to the stock market during economic recessions. I have written about the Simple 50/50 model before. The Simple 50/50 model consists of 50% of the portfolio value invested in the iShares Core S&P500 ETF ticket IVV and the remaining 50% of the value invested in the iShares 20+ Year Treasury Bond ETF ticket TLT. This model was successful at mitigating the downside risk during the financial crisis as well as during the Covid-19 pandemic (Simple 50/50). It is just one of the simple examples of a diversified portfolio.
Investing Principle # 10: Be aware of individual company risk and do your homework
Investing in individual company stocks may provide an attractive potential return but it comes with both company specific and market risk combined. Most investors like to brag about the high performing stock picks they made during cocktail parties, it is very exciting to pick the winner and tell stories. Nobody is excited to talk about investing in a well-diversified Exchange Traded Fund (ETF). ETF is the basket of securities designed to follow the performance of its benchmark. Sometimes boring investing is more prudent for beginner investors.
Investing in individual company stocks may provide an attractive return but it comes with a significant risk. The investor takes on both market and individual company risk. When the overall market is down, the individual company stock is likely to be down as well. Also, by purchasing the company stock you assume its individual risk. Individual risk consists of company’s business performance, financial results, competitive environment, and changes in management. It is time consuming and requires both knowledge of financial statements and practical experience to learn about company specific risks. Beginner investor may find it easier to pick ETFs and create a diversified portfolio without exposing yourself to the company specific risk.
Investing Principle # 11: Select the right financial advisor who will represent your best interest
At some point in the future, you may want to seek help of a financial advisor. Financial advisor can provide education, advice and help you reach your financial goals. He or she can also do all the research and monitor your portfolio, so you can enjoy life. How should you select the right financial advisor? To help you with that, the CFA Institute has developed the Statement of Investor Rights. They reflect fundamental ethical principles, understanding of your needs, clear communication and full transparency. The next time you interview a prospective financial advisor, you can bring the CFA Institute Statement of Investor Rights with you to make sure your rights will be protected (CFA Institute Statement of Investor Rights).
Investing Principle # 12: There are no short cuts. If it is too good to be true, it probably is.
With a recent hype around GameStop and stories of investors turning $500 into $200,000, you may fall a victim of the cognitive bias – bandwagon effect. Just because more and more people are buying GameStop, you may want to join the group, be included in making a lot of money fast. The cognitive bias makes it easy to jump in without doing your homework. You may ask yourself: what can go wrong if everybody is doing it? Investments that are based on hyped news and popularity, without fundamental reasoning are very risky. At some point the market price will have to match the true value of the company. The disaster will happen sooner than you think, when reality settles in. It is very difficult to time the market and be the first one out of the door. When suddenly the music stops and everybody runs for the exit, the price will fall dramatically.
There will be many more GameStop like companies in your life. You will hear many classical pump-and-dump stories of people trying to profit from trusting investors. Pump-and-dump scheme is illegal activity by perpetrators trying to boost the stock price through false, misleading or greatly exaggerated information (Investopedia). The perpetrators have already purchased the stock at a low price and want others to drive the price higher based on false information. The perpetrators will then sell shares at a higher price.
Besides unpleasant learning experience, large speculative losses have come with a significant negative social impact on investors. Many investors in speculative securities will lose a lot of money. With large losses, these investors will also lose confidence in the financial system. They will be afraid to invest again and will miss on future opportunities to benefit from the financial system. These people will have more difficult time breaching the inequality gap without the stock market help. That is a negative social effect of the stock market on new investors.
Do your homework before you invest, if there is no fundamental value behind the stock price, it becomes a speculative bet. You can invest some of your money that you can afford to lose. Your main portfolio should be well diversified with good quality companies or broad market ETFs.
Investing Principle # 13: Information travels near the speed of light. Do not try to overrun it.
The financial markets are pretty efficient. High frequency traders have fiberoptic cables in close proximity to major US stock exchanges. Many trades are done using computer algorithms. These trades are executed near the speed of light. Whenever you hear or see new information, it is already incorporated in the stock price. All the news you hear on CNBC or Bloomberg are already reflected in stock prices within fractions of a second. The light travels about 124,188 miles per second through the fiber optic cables (Brodsky). So, if a trading firm has a server within a mile of major stock exchanges, it can execute trades within 0.000008052 second after the news hit the market. Most retail investors do not have the technology to execute trades before professional traders with computer power and fiberoptic cables in close proximity to exchanges.
Investing Principle # 14: The stock markets are informationally efficient and may provide opportunities for long term investors.
The stock market is informationally efficient. It reflects nearly all available public information in the stock prices. You have an opportunity to know about the company and the stock price as much as anybody else can legally. For the most beginner investors, selecting a broadly diversified ETFs with a low cost is probably the best way to start investing.
Eugene F. Fama won Noble Prize in Economics for his work on the efficient market hypothesis. According to Fama, the stock prices fully reflect all available information if the following conditions are met:
According to Fama, markets may still be efficient even if sufficient number of investors meet the above three conditions (Fama 1970). Fama showed that the financial markets may fully reflect past price, return history, and publicly available information. It is highly unlikely that past price data may predict future stock performance consistently and with high enough profitability margin. Only monopolistic access to information may not be reflected in stock prices. The example of such information is the specialist’s confidential book information about submitted limit orders to buy and sell stock (Fama 1970). The specialist’s book information is material and nonpublic. Retail and institutional investors do not have the monopolistic access to information.
However, it is possible to have information which is not immediately reflected in the stock prices. According to Fama, there can be informational signals that are not immediately accepted by the stock market. In this case, the future value will be higher than present value. It is analysts’ job to interpret information correctly and take advantage of investment opportunities over time.
In the long run, the stock market may provide an opportunity to profit. If you are willing to do the homework and learn financial statement analysis and economics, you may try to outperform the market by selecting individual securities. One way to do that is to interpret information correctly and define information which is not currently reflected in the stock price. When you discount the future information to present time, you can compare your target price with the market price. If your target price is significantly higher than the market price, you may decide to purchase this security. After the purchase, you will have to wait for the market to realize what you have forecasted. If your predictions are correct, the future stock price will move closer to your target price. Here are some of the risks in trying to outperform the market:
Investing Principle # 15: The stock market is forward looking.
As we have discussed in section 14, the stock market is informationally efficient. The efficient market hypothesis gained even more strength recently with the technological advances in commission free trading, fiberoptic internet speed, and greater market participation. Most of the historical information is immediately reflected in the stock prices.
Besides being informationally efficient, the stock market is also a forward-looking indicator. Analysts evaluate stock prices based on companies’ future revenue growth and profitability expectations. Active investors position capital into securities of companies they feel could benefit from future growth. As the result, today’s stock prices reflect not only historical information but also future expectations.
Conclusion:
The fifteen investing principles create the foundation of investing. Before you go on to build your wealth castle, you need to understand how to build a strong foundation. This is the starting point of your investing journey. The learning process of being a successful investor only starts here and continues through your life.
References:
Brodsky Paul. The Speed of Light Never Changes—Except When it Does. https://blog.telegeography.com/the-speed-of-light-never-changes-except-when-it-does
CFA Institute Statement of Investor Rights.
Daniel Kahneman and Amos Tversky. “Choices, Values, and Frames.” American Psychologist. Vol. 39, No. 4, p. 341-350. April 1984.
Fama Eugene F. Efficient Capital Markets: A Review of Theory and Empirical Work. The Journal of Finance, Vol. 25, No. 2, Papers and Proceedings of the Twenty-Eighth Annual Meeting of the American Finance Association New York, N.Y. December, 28-30, 1969 (May, 1970), pp. 383-417
Financial Times, How America’s 1% came to dominate equity ownership; https://www.ft.com/content/2501e154-4789-11ea-aeb3-955839e06441
Investopedia. Pump-and-dump. https://www.investopedia.com/terms/p/pumpanddump.asp
IRS. Traditional and Roth IRAs. https://www.irs.gov/retirement-plans/traditional-and-roth-iras
Ivan Sichkar. “Smart Cash Management Can Decrease Risk and Increase Returns.”
https://ecnfin.com/2012/09/30/smart-cash-management-can-decrease-risk-and-increase-returns/. September 2021.
Data:
The Federal Reserve, Distribution of Household Wealth in the U.S. since 1989; https://www.federalreserve.gov/releases/z1/dataviz/dfa/distribute/table/#range:2005.3,2020.3;quarter:124;series:Net%20worth;demographic:networth;population:1,3,5,7;units:shares
Disclosures:
The analysis is based on historical data and future expectations that may not be correct. This paper was written as an opinion only. The data is not guaranteed to be accurate or complete. Please consult with your financial advisor, before making an investment decision. Neither ECNFIN.COM nor its author are responsible for any damages or losses arising from any use of this information.
ECNFIN.com and its podcast are not associated with nor do they necessarily represent the opinion or advice of Epiqwest Culver Wealth Advisors LLC. Past performance doesn’t guarantee future results.
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Abstract:
Oftentimes a successful investing requires the time commitment, ability, and wiliness to take risk. When it comes to the real life, very few investors have the luxury and wiliness to meet these conditions to become successful. In this paper, I analyze the stock market risk and highlight difficulties to remain calm and rational during volatile times. For risk averse investors, one of the solutions is to have a diversified portfolio. The simple 50/50 asset allocation strategy combines a broadly diversified equity index with long-term government bonds. It is one example of a simple diversification strategy.
Paper:
Investing in the stock market can be rewarding. Let’s break down the prior sentence. Definition of investing is to commit (money) in order to earn a financial return (Merriam-Webster dictionary). The key word is to commit. You must commit for a long-term in order to fully benefit from investing. Long-term commitment allows investors to go through ups and downs of the stock market and come out with a positive gain. Sometimes, you need to provide enough time for your investment to be noticed by the rest of the market participants.
However, it is easier said than done. We are all human and have many limitations that may break our commitment to invest and wait. We are all subject to behavioral biases such as loss aversion. Loss aversion expresses the intuition that a loss of $X is more aversive than a gain of $X is attractive (Daniel Kahneman and Amos Tversky, 1984). When investors feel the pain from losing money in the short-term, they may be inclined to sell when the stock market is down. By selling stocks when the market is down, will create realized losses and prevent investors from a future possible recovery.
Another limitation that most investors face is the personal time horizon. Benjamin Franklin wrote before: “in this world, nothing is certain except death and taxes” (Constitution Center). We all have our personal time horizon in terms of living years. However, we do not know for certain the duration of our time horizon. The death is certain, but the exact time is not. We may not guess exactly how many years we may have left. Thus, we cannot know the duration of our lifetime horizon with certainty.
What is required to be a successful investor? First, the stock market requires a long-term commitment to be a successful investor. Second, we are all human and subject to behavioral biases. We may experience loss aversion and sell when the market is down. Third, even if we can control our emotions, we are certain to have the end of our living years at some unknown point. The duration of the living years is uncertain and creates the risk for investors.
What should we do by knowing the requirements, risks and future uncertainty? We can visually and mathematically analyze the stock market risk and come up with a practical solution. Let’s review the performance of the stock market in 2020 and see how you may have reacted or did react. The year 2020 was unique by its high volatility and a very brief stock market correction. During the year we saw a sharp selloff and equally impressive rebound in a very short time period. Thus, the year 2020 is a great case study of what may happen in the future and how one may react.
Let’s try to analyze the risk quantitatively and visually. I will use the standard deviation to quantitatively measure the risk. According the Investopedia: “The standard deviation is a statistic that measures the dispersion of a dataset relative to its mean and is calculated as the square root of the variance.” For the normally distributed data set, one standard deviation of the mean represents about 68%; and two standard deviations represent about 95% of possible outcomes.
If you are invested in the S&P 500 Index or portfolios similar to this index, you had to experience the following risks in 2020. I will use iShares Core S&P 500 ETF ticker IVV as a proxy to the S&P 500 Index. The daily standard deviation for the IVV was 5.92% in March 2020 (see Table 1). This means that on any single day, there is 68% chance that your portfolio can go up or down by 5.92%. Also, there is 95% change that your portfolio can go up or down by two standard deviations or 11.84% on any single day in March 2020. If that does not scare you, lets convert the daily risk to monthly and annual numbers. The monthly standard deviation was 27.79% in March 2020. For one month of March 2020, there was 68% chance that your portfolio can go up or down by 27.79%. By increasing the probability to 95%, there is a change that your portfolio could swing plus or minus 55.58% just in one month. Now let’s convert monthly standard deviation to annualized standard deviation. For the month of March 2020, the annualized standard deviation was 94.05%. If the entire year was similar in volatility to March 2020, there is 68% chance that your portfolio could go up or down by 94.05%. By increasing the probability to 95%, the swing in your portfolio values is between plus and minus 188%.
By closing your eyes and visualizing March 2020 with a wild volatility and unknown future ahead, would you have strength to stay calm and hope for the best? What if the rest of the year was similar to March? That would mean you could have made plus or minus 94% of your portfolio using 68% probability (see Chart 1). Would you be willing to risk it all? Fortunately, we know that the rest of the year was not the same as March 2020 and we saw a nice recovery. However, nobody knows what the future will hold, the next time will be different.
Usually, the stock markets have quick corrections which create attractive valuations and attract new buyers. In reality and under normal circumstances, attractive fundamental values and high dividend yields, attract new buyers. A normal stock market correction does not usually last long. However, sometimes we have prolonged rescissions that can last years; such as, the financial crisis of 2008 or dotcom bobble.
You should be prepared to risk it all and may need to wait multiple years to see your portfolio to recover. For example, the dotcom bobble caused Nasdaq index to rise to 5,048.62 on March 10, 2000. When the dotcom buddle did burst, the Nasdaq fell by 76.81% all the way to 1,139.90 on October 4, 2002. It took about thirteen years for the Nasdaq to return to 5,000 level on July 2015. Some stock market corrections can take a long time to recover from.
Some investors may have the high-risk tolerance and ability to ignore a steep decline in the stock prices. Even these investors face the risk of uncertainty – their own time horizon. As I discussed above, the death will come for certain but when that day will come is everybody’s assumption and guess. Life expectancy is the risk because we cannot predict it with certainty. So even the risk averse investors may not be able to wait for the stock market to recover due to uncertain death.
Investors may be able to control the behavioral bias, such as, loss aversion. Even though, it is very difficult to do even for professional investors. All investors are subject to certain future death with uncertain date. This creates uncertain time horizon. Knowing about these risks, what solutions can investors implement in managing money?
Diversification becomes very important in portfolio construction. A well-diversified portfolio may lower the risk while providing returns on investments. There are many ways to diversify. One simple solution that may work is to combine asset classes that behave differently when the stock market declines. I find that the US Government long-term bonds tend to provide a valuable benefit of a negative correlation to the stock market during economic recessions. I have written about the Simple 50/50 model before. The Simple 50/50 model consists of 50% of the portfolio value invested in the iShares Core S&P500 ETF ticker IVV and the remaining 50% of the value invested in the iShares 20+ Year Treasury Bond ETF ticker TLT. This model was successful at mitigating the downside risk during the financial crisis as well as during the Covid-19 pandemic (Simple 50/50).
First, let’s review the individual risks for the iShares Core S&P500 ETF ticket IVV and iShares 20+ Year Treasury Bond ETF ticker TLT. How much risk did investor assume by holding TLT or IVV during March 2020? The daily standard deviation for the IVV was 5.92% in March 2020 (Table 1 and Chart 1). The daily standard deviation for the TLT was 3.77% in March 2020 (Table 2 and Chart 2). Each selected asset class comes with a significant risk. If you were invested in the IVV, with 68% probability, you would expect your portfolio to be up or down 5.92% on any single day during March 2020. On the other hand, if you put all your money in the long-term government bonds, with 68% probability you would expect your portfolio to be up or down 3.77% on any single day in March 2020. Both equities and government bonds have significant risk by themselves.
However, by combining two negatively correlated asset classes, the entire portfolio risk goes down during the year 2020. The total risk for the Simple 50/50 portfolio is lower than the individual risk of IVV and TLT alone. When I combine both IVV and TLT together and create the Simple 50/50 Model, the total portfolio daily standard deviation falls to 2.57% during the March 2020 (see Table 3 and Chart 3). I was able to lower the risk by 56% in comparison to investing in the IVV only or by 32% in comparison to investing in the TLT only. By creating the portfolio with the two negatively correlated asset classes, I was able to decrease the risk significantly during the year 2020 (see Chart 3).
So far, we have established that diversification can lower overall portfolio risk based on the above analysis of the Simple 50/50 model during the year 2020. However, how does the performance of this model compare to the performance of its components: IVV and TLT? As we know, the year 2020 was volatile but overall positive for the stock market. There was a sharp decline in February and March and equally impressive recovery afterwards (Chart 4). In contrast, investments in the TLT did very well at the beginning of the year and then declined during the second half (Chart 5). Individually, IVV and TLT performed differently on any single month but overall had a good year in 2020. You can visually see how diversification works, when one asset class provides downside protection for another asset class.
Now, let’s analyze the performance of the Simple 50/50 model during the year 2020. This model had lower volatility / lower risk during the year 2020 (Chart 6). The biggest losses were in March 2020, when the Simple 50/50 model lost -2.88% and October 2020 when the model lost -2.95% (Chart 6). In comparison, investments in IVV saw a decline of -12.13% in March 2020 (Chart 4). Also, if you were fully invested in TLT exclusively, your investment was down -5.05% in August 2020 and -3.39% in October 2020 (Chart 5).
Next, I compare the monthly performance of three investments: IVV, TLT, and the Simple 50/50 Model side by side (Chart 7). The Simple 50/50 Model displays less volatility and is positioned in the middle between IVV and TLT (Chart 7). As the saying goes, slow and steady wins the race. It is true for the Simple 50/50 model which outperformed both IVV and TLT in the year 2020 (Chart 8). The total return for the Simple 50/50 model was 19.88% vs. 18.40% for IVV and 18.15% for TLT during the year 2020 (Chart 8).
The Simple 50/50 model is a diversified portfolio with lower risk than its individual components. It also provides equity like potential returns. Because of its lower volatility, this model helps to control the behavioral biases such as loss aversion. Very few investors can stomach monthly volatility of plus or minus 55.58% which is based on the standard deviation for the IVV during March 2020. Even if you can control your emotions, you cannot control your time horizon. The duration of the living years is uncertain and creates the risk. Investment requires a long-term time horizon to be successful. A sharp stock market correction may be followed by a very slow and gradual recovery. It may take years to recoup the losses. Since you may not have the luxury to wait and ability to control your time horizon, the decline in portfolio values may become permanent. A prudent solution for many investors is to have a diversified portfolio with lower standard deviation – risk. One example of such portfolio is the Simple 50/50 model.
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References:
Constitution Daily. Benjamin Franklin’s last great quote and the Constitution, https://constitutioncenter.org/blog/benjamin-franklins-last-great-quote-and-the-constitution
Daniel Kahneman and Amos Tversky. “Choices, Values, and Frames.” American Psychologist. Vol. 39, No. 4, p. 341-350. April 1984.
Investopedia, https://www.investopedia.com/terms/s/standarddeviation.asp
Merriam-Webster dictionary, https://www.merriam-webster.com/dictionary/invest
Simple 50/50 Asset Allocation Model – Proven to Withstand the Financial Crisis of 2008, https://ecnfin.com/2012/10/07/simple-5050-asset-allocation-model-proven-to-withstand-the-financial-crisis-of-2008/
The Simple 50/50 Asset Allocation Model – Proven to Withstand the Financial Crisis of 2008 and Covid-19 Pandemic, https://ecnfin.com/2020/09/16/the-simple-50-50-asset-allocation-model-proven-to-withstand-the-financial-crisis-of-2008-and-covid-19-pandemic/
Data:
Yahoo! Finance. S&P 500, IVV and TLT Price Data was retrieved from http://finance.yahoo.com
Disclosures:
The analysis is based on historical data and future expectations that may not be correct. This paper was written as an opinion only. The data is not guaranteed to be accurate or complete. Please consult with your financial advisor, before making an investment decision. Neither ECNFIN.COM nor its author are responsible for any damages or losses arising from any use of this information. ECNFIN.com and its podcast are not associated with nor do they necessarily represent the opinion or advice of Epiqwest Culver Wealth Advisors LLC. Past performance doesn’t guarantee future results.
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President elect Joe Biden nominated Janet Yellen as the 78th United States secretary of the treasury. In my opinion, Janet Yellen will support aggressive fiscal stimulus of the US economy at the beginning of her new job. Her prior experience as the chair of the Fed will create a bridge and very favorable relationship between the current Fed chairman Jerome Powell and the US Treasury Department. Both Yellen and Powell share similar interests in helping the economy and unemployment first at the expense of short-term increase in inflation. Her prior job history and academic research show great interest in fighting inequality and unemployment. Even energy sector may do very well during the current administration.
Before her current nomination, Dr. Yellen has also worked as the chair of the Fed. Janet Yellen succeeded Ben Bernanke as the chair of the Board of Governors of the Federal Reserve System in February 2014 and held the position for four years (the Federal Reserve History). During her leadership at the Fed, the interest rates went from zero in 2014 to 1.25%-1.5% by February 2018 (Open Market Operations). Dr. Yellen first voted to increase interest rates by 0.25% in December 2015 when unemployment was at 5%. The second interest rate hike by another 0.25% was a year later when unemployment dipped to 4.7% in December 2016. Dr. Yellen waited a year and took time to watch and make sure unemployment continued to decline before raising interest rates. She is considered more dovish economist who prefers to have lower interest rates and lower unemployment. Her economic believes are shared with the current Fed chairman Jerome Powell. Mr. Powell also likes to see the economy and unemployment improve at the expense of any short-term increase in inflation. He is also considered a dovish economist.
Dr. Yellen has written research on labor economics and believes in the specific level of full employment (Barron’s). When economy reaches the full employment, the government should start withdrawing stimulus policies. Right now, we are in the opposite situation – when economy is far from full employment. The recent increase in unemployment should provide additional reasons for Dr. Yellen to support more aggressive fiscal stimulus. According to the U.S. Bureau of Labor Statistics, the unemployment rate has risen from 3.5% in February 2020 to 6.7% in November 2020.
Dr. Yellen has studied and wrote about growing inequality as a big concern. Inequality got even worse during the Covid-19 pandemic. Many low-income jobs were lost. The Main Street felt much pain and has not recovered from the pandemic still. In contrast, the Wall Street saw the stock prices fully recovered and even reached new record levels. Wealthy people own most of the stock market and their wealth increased during the pandemic widening the inequality gap. The richest one per cent of Americans own more stocks than half of the US households, according to the Goldman Sachs (Financial Times). Also, the top one per cent of Americans own 31% of all household wealth. In contrast, the bottom 50% of Americans own only 2% of household wealth according to the Federal Reserve. These statistics should support more aggressive fiscal stimulus, especially for lower income families. We should expect more stimulus checks being mailed early in 2021.
Fiscal stimulus in form of check payments to low-income families will fuel the economic recovery. Most low-income families will spend the entire stimulus payment fast contributing to economic growth. The multiplier effect on the economy by issuing stimulus checks will be much greater than the original amount on the checks. The multiplier effect may be felt by the banking system which will receive some of the deposits and will be able to lend more money out. By spending money on goods and services, the multiplier effect will pass on extra income to producers and sellers of goods and services. As the result, companies and the stock market may also benefit from additional spending. Some stimulus money may even be used directly to purchase stocks. However, I would argue that low-income families may not have the luxury to afford stocks.
Dr. Yellen has advocated for climate improvement through carbon tax and dividend (Barron’s). Big energy companies will either pay or earn dividend based on the pollution levels produced. It may have a negative effect on profitability of big energy companies. However, the carbon tax and dividend are not a new phenomenon. The increase in economic growth due to stimulative fiscal and monetary policies will outweigh negative effect of carbon tax. Energy sector may also do well during new administration. Janet Yellen as a new secretary of the treasury should be very positive for economic recovery and labor market. Both the treasury department and the Fed should be on the same page and willing to do everything to lower unemployment and stimulate economic growth. Fiscal policies have quick, instantaneous effect on the economy. With the new expected round of stimulus checks and other financial help, we will see economy improving right away. At the same time, the Fed will also continue to pursue stimulative monetary policies that have more long-term effect on the economy. The new administration is shaping out to be very good for the economy which needs help.
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References:
Barron’s, Who Is Janet Yellen, Biden’s Pick for Treasury? Former Fed Chief Has a History of Hits and Misses; https://www.barrons.com/articles/who-is-janet-yellen-bidens-pick-for-treasury-former-fed-chief-has-a-history-of-hits-and-misses-51606175101
Financial Times, How America’s 1% came to dominate equity ownership; https://www.ft.com/content/2501e154-4789-11ea-aeb3-955839e06441
The Federal Reserve History, https://www.federalreservehistory.org/people/janet-l-yellen
Data:
Open Market Operations, https://www.federalreserve.gov/monetarypolicy/openmarket.htm
The Federal Reserve, Distribution of Household Wealth in the U.S. since 1989; https://www.federalreserve.gov/releases/z1/dataviz/dfa/distribute/table/#range:2005.3,2020.3;quarter:124;series:Net%20worth;demographic:networth;population:1,3,5,7;units:shares
U.S. Bureau of Labor Statistics, Unemployment Rate [UNRATE], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/UNRATE, January 19, 2021.
Disclosures:
The analysis is based on historical data and future expectations that may not be correct. This paper was written as an opinion only. The data is not guaranteed to be accurate or complete. Please consult with your financial advisor, before making an investment decision. Neither ECNFIN.COM nor its author are responsible for any damages or losses arising from any use of this information. ECNFIN.com and its podcast are not associated with nor do they necessarily represent the opinion or advice of Epiqwest Culver Wealth Advisors LLC. Past performance doesn’t guarantee future results.
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This is my 9th annual forecast of the S&P 500 Index return for the year. This forecast tends to predict a general pattern, direction, of the stock market in the future. When the forecast calls for a negative return, it is a warning sign. It means that the market is ahead of itself and may see a poor performance and volatility in the next 12 months. My forecast does not predict an absolute number rather it gives an overall feeling for the general direction of the stock market in the future.
The year 2021 maybe a bad year for the S&P 500 Index. My model predicts a negative return for the year 2021. This means that the stock market is ahead of itself and may experience a correction and volatility in the next 12 months.
My model is based on the simple linear regression model. The model uses Gross Domestic Product (GDP) as explanatory variable to the performance of the S&P 500 Index. The model predicts the S&P 500 Index to close between 3,390 and 3,480 at the end of the year 2021. This represents a negative return between -7.3% and -9.7% for the year. If my forecast is correct, the year 2021 will provide a negative return to equity investors. Investors may not be fully compensated for taking the market risk. It is time to be cautious about taking on equity risk.
During the last eight years, the model had proven to predict the general direction of the stock market performance. Projections by the model and actual stock market performance track each other (see Chart 1). Even for the year 2020, the model predicted a decline in returns which was a correct trend from the prior year. For the year 2021 the model predicts a significant negative return between -7.3% and -9.7%. This should make investors more cautious during the next 12 months.
When I compare historical predictions for the S&P500 Index performance with actual returns of the S&P500 Index, I can see a positive correlation (see Chart 1). The model may provide a general understanding of whether the stock market is overprices or inexpensive. The model does not guarantee or precisely predicts the outcome. It has correctly projected up and down markets six out of eight years (see Table 1). Despite a significant margin of error, the model does give a general feel for the value of the stock market. It does track the performance of the stock market.
The forecast model may provide the basis to evaluate the stock market and to determine if it is oversold or underbought. There is also a wide margin of error. The expected performance for the S&P 500 Index may have a wide deviation from the actual index each year.
Now, let’s review the forecast for the year 2021. Where will the S&P 500 Index close one year from now, on December 31, 2021?
Based on the statistical analysis and the process described further in this article, I expect the S&P 500 Index to close between 3,390 and 3,480 at the end of 2021. Based on this range, the midpoint for the S&P 500 Index is predicted to be at 3,435 on December 31, 2021 (see Table 1). This translates into a potential annual decline of -8.5% for the S&P 500 Index.
This prognosis is based on expected Gross Domestic Product (GDP) of the United States in nominal terms, current USD terms. First, I take the most recent GDP number. It will be the base from which I calculate the expected nominal GDP. According to the Bureau of Economic Analysis, the current dollar GDP was $21,170.3 billion for the third quarter of 2020 year (December 22, 2020).
According to the economic projections of the Federal Reserve Bank Board Members and Federal Reserve Bank Presidents made on December 16, 2020, the real GDP is expected to increase between 3.7% and 5.0%, and Personal Consumption Expenditure is expected to increase between 1.7% and 1.9% for the year 2021. As a result, the nominal GDP estimated to rise between 5.4% and 6.9% in 2021.
By multiplying the current dollar GDP for 2020 by expected nominal change for the year, I calculate the GDP for the year 2021 to be between $22,313.50 and $22,631.05 billion. Now I can forecast where the S&P 500 Index will close at the end of 2021. I am using the Excel spreadsheet to run a linear regression model where the S&P 500 is a dependent variable, and GDP is the independent variable. Based on the last 15 years of annual data, I forecast the S&P 500 Index to close between 3,390 and 3,480 at the end of 2021 (see Table 2).
The model predicts a significant decline in the S&P 500 Index for the year 2021. It should be a sign of caution for investors. The actual return may be significantly different from the prediction. However, the model indicates that we may experience volatility and the stock market correction in the next 12 months.
Limitations to the forecast:
Based on my prior research, the GDP alone can only explain between 67%-89% of the performance in the S&P 500 Index (see my prior articles on http://www.ecnfin.com). The remaining 11%-33% is not influenced by the GDP growth. There might be other factors that are difficult to predict; such as, geopolitical risk, rise in inflation, and black swan events that nobody expects.
By using a smaller sample of data, I am able to focus on the current economic environment. The model does not incorporate information from historical economic cycles. That was done on purpose to focus more on the current economic environment. Because of this, the sample data is limited to more recent years.
Disclosures:
The forecast of the future S&P 500 Index is based on historical data and future expectations that may not be correct. This paper was written as an opinion only. The data is not guaranteed to be accurate or complete. Please consult with your financial advisor before making an investment decision. Neither ECNFIN.COM nor its author are responsible for any damages or losses arising from any use of this information.
ECNFIN.com and its podcast are not associated with nor do they necessarily represent the opinion or advice of Epiqwest Culver Wealth Advisors LLC. Past performance doesn’t guarantee future results.
References:
The Federal Reserve Bank, December 16, 2020 https://www.federalreserve.gov/monetarypolicy/fomcprojtabl20201216.htm
Data:
U.S. Department of Commerce. Bureau of Economic Analysis. Gross Domestic Product data was retrieved on January 3, 2021 https://www.bea.gov/news/2020/gross-domestic-product-third-estimate-corporate-profits-revised-and-gdp-industry-third
Yahoo! Finance. S&P 500 Price Data was retrieved from http://finance.yahoo.com
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Current valuation of government bonds became expensive. In this paper, I compare the total return on the iShares 20+ Year Treasury Bond ETF (ticker TLT) with the real yield on the 10-year US treasury bonds. By investing in the long-term US government bonds when the real rates are negative, makes such investment speculative and risky.
The daily real yield on the 10-year US treasury bonds is at the historical lowest level. The real yield on the 10-year US Treasury bonds was -0.96% on December 10, 2020, according to the Federal Reserve Bank of St. Louis data. As investor in the long-term government bonds, you can expect to earn negative income after inflation for the next ten years. The downside risk of investing in the US government bonds is much greater than any short-term upside potential in my opinion.
Why would you invest in securities that earn a negative return? The only reason is to believe that the interest rates can decline further. The price of bonds is negatively correlated with interest rates. As rates decline, the price of bonds increases. If you believe that the interest rate may decline further, then investing in the US government long-term bonds may provide price appreciation despite negative real income.
By comparing the real yield on the 10-year US treasury with the performance of the investment in the long-term government bonds, you can visually see when the bond market becomes expensive (see chart 1). In this chart, I compare the return on $100,000 invested in the iShares 20+ Year Treasury Bond ETF (ticker TLT) vs. the real yield on the 10-year US treasury (data provided by Yahoo Finance! and Federal Reserve Bank of St. Louis). The bond portfolio invested in the TLT grew form $100,000 on January 2, 2003 to $337,790 as of December 10, 2020. It was amazing 17 years performance for the US treasuries. However, it was not all smooth on the upside. You may notice when the real rates stay positive, the US treasuries do relatively better than when real rates go negative. When real rates went negative from July 2012 until May 2013, the US treasury bonds performed poorly the following year, 2013-2014. Current real yield on the 10-year US treasury reached a new record low point of -0.96%. This is the reason to be cautious about investing in the long-term treasury bonds.
When the real rates are positive and it least one percent, it provides additional reason to hold long-term US Government bonds. At least you are earning a positive income above inflation. Also, the performance of the TLT portfolio did relatively well when the real rates reach positive territory. When the real rates reached above one percent in 2014, the following year was very good for holding treasuries. Similarly, rates went above one percent in 2019, and treasuries performed amazingly well the following year.
Real interest rates provide additional valuation tool to determine whether the bond market maybe expensive or not. When the real interest rates are positive, the investor is earning income above inflation. When the real interest rates are negative, the income from the bond portfolio will not compensate for inflation. It should also signal a warning sign that bonds maybe too expensive.
Data:
Yahoo! Finance. https://finance.yahoo.com/ data accessed on December 12, 2020
Federal Reserve Bank of St. Louis. https://fred.stlouisfed.org/series/DFII10 data accessed on December 12, 2020
Disclosures:
The analysis is based on historical data and future expectations that may not be correct. This paper was written as an opinion only. The data is not guaranteed to be accurate or complete. Please consult with your financial advisor, before making an investment decision. Neither ECNFIN.COM nor its author are responsible for any damages or losses arising from any use of this information.
ECNFIN.com and its podcast are not associated with nor do they necessarily represent the opinion or advice of Epiqwest Culver Wealth Advisors LLC. Past performance doesn’t guarantee future results.
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The effect of the Covid-19 on the stock markets around the world was widespread. Most major equity markets around the world witnessed a steep decline in the stock prices. However, the degree of the stock market correction and recovery was different from one country to another. How did various stock markets around the world weather the Covid-19 pandemic?
The Covid-19 originated in Wuhan, China. By being the ground zero, you may expect the Chinese stock market to suffer the most from the Covid-19 pandemic. Surprisingly, the Chinese stock market declined the least among major world stock markets. iShares MSCI China ETF (MCHI) was down only -19.17% during Feb 19-March 23rd, 2020. Also, the Chinese stock market is the best performing market year-to-date. The Chinese stock market was up 12.13% year-to-date based on iShares MSCI China ETF (MCHI) (see Chart 1). All year-to-date numbers in this paper are calculated for the time period from January 1, 2020 through September 25th, 2020. The stock market correction period is assumed to be between Feb 19th through March 23rd, 2020. The stock market recovery period is from March 23, 2020 through September 25th, 2020.
The US stock market was the second-best performing stock market year-to-date. After the initial sharp sell-off by 33.9% the US stock market saw a V-shaped recovery. The US stock market was up almost 50% after the bear market selloff. For the year-to-date, the US stock market was up 3.59% based on the iShares Core S&P 500 ETF (IVV) (see Chart 1).
The Japanese stock market was the third best performing stock market year-to-date. The Japanese stock market was initially down -22.34% based on iShares MSCI Japan ETF (EWJ). However, it has also experienced a steep recovery and covered all its loses year-to-date.
On another hand, the three worse performing stock markets year-to-date were the United Kingdom, Russia, and France. The UK Stock market failed to recover its massive, more than 40%, initial losses during the Covid-19 pandemic. The UK stock market is still down -25% year-to-date based on the iShares MSCI United Kingdom ETF (EWU). The Russian stock market experienced the decline of 39.41% during the Covid-19 selloff and failed to recover. The Russian stock market is still down -23.63% year-to-date based on iShares MSCI Russia ETF (ERUS). The French stock market was down -36.84% during the Covid-19 selloff and remains -15.37% year-to-date based on iShares MSCI France ETF (EWQ).
The effect of the Covid-19 on the stock markets around the world was widespread and sharply negative. However, some stock markets saw a V-shaped recovery whereas others failed to recover and remain far in the red still. The three best performing markets year-to-date were the Chinese, the US and the Japanese stock markets. These three stock markets managed to recover all initial losses and enter a positive territory year-to-date. On another hand, some countries were not as lucky. The UK, Russian and French stock markets were still down more than double digits year-to-date.
Data:
Yahoo! Finance. Data was retrieved from http://finance.yahoo.com
Disclosures:
The assumptions of the countries’ stock market performance were based on selected iShares Exchange Traded Funds performance. These ETFs were used as a proxy to represent each country’s stock market performance. There are many other different sectors and indexes available that you may consider. The results may vary based on what index you select.
The analysis is based on historical data and future expectations that may not be correct. This paper was written as an opinion only. The data is not guaranteed to be accurate or complete. Please consult with your financial advisor before making an investment decision. Neither ECNFIN.COM nor its author are responsible for any damages or losses arising from any use of this information.
ECNFIN.com and its podcast are not associated with nor do they necessarily represent the opinion or advice of Epiqwest Culver Wealth Advisors LLC. Past performance doesn’t guarantee future results.
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