If you are confused by the stock market, you’re not alone. If you spend 20 minutes watching any of the financial news networks, you’ll be exposed to multiple opinions about where we are headed. Some think we are gliding in for a soft landing. Others say you should assume the crash position. And there are myriad opinions in between. To simplify things, I think there are roughly three potential paths the market could take. Two of them likely don’t pose long-term challenges to investors, but one does.
Soft Landing. You’ve heard it time and time again from our government officials, but the Fed’s goal is a soft landing. What that basically means is the Fed wants to bring inflation back to 2% without meaningfully slowing down the economy or causing much of an uptick in unemployment. It could happen, but many things have to go right for the Fed. If the Fed can engineer this result, expect the stock market to rally and interest rates on bonds to fall. We’ll basically be back to where we were in 2019. I put the odds of this at about 30%.
Hard Landing. A hard landing means the Fed drives inflation down to 2% regardless of how much pain it causes the economy. That means we may experience a tough recession and a significant rise in unemployment. Traditionally, this is how the Fed solves inflation. The Fed must crush demand to see prices fall. And to crush demand, people have to lose their jobs. If not, consumers basically keep spending. Because consumer spending is 70% of the economy, the theory is you can’t stop the inflation juggernaut until you stop consumers.
If we head down this path, expect the stock market to fall fairly significantly, somewhere between 30% and 50%. But, the good news is, if the Fed brings down inflation to 2%, markets should recover once it’s clear the inflation genie is back in the bottle. It won’t be comfortable, but the stock market declines should be in the rearview mirror within a few years.
I’d put the probability of this outcome at about 50%.
Stagnation. This third scenario is the more troubling one in terms of its potential impact on your retirement portfolio. It’s possible we could head down a path where the Fed doesn’t bring inflation to 2%. It could happen a couple of ways. First, if the Fed can’t engineer the soft landing and decides it’s not worth the damage to push the economy into a deep recession, they may simply revise their goals. They could say something like, “We want to get to 2%, but not yet.” This leaves the 2% goal on the table, but pushes out the time horizon.
Conversely, the Fed may not be able to bring inflation to 2% even with a hard landing. There are many factors impacting inflation. If the Fed knew exactly what caused it, we wouldn’t have gotten any. So, it’s certainly possible given the complexity of global markets that just raising interest rates may not be enough.
I’d say the odds of some sort of stagnation are maybe 20%. It’s the least likely outcome, but the most troubling. A stagnation may cause investors to lose faith in the Fed and begin to rethink how they value stocks, bonds and real estate.
If we head down the soft or hard landing paths, investors probably don’t need to do too much. The market will likely recover, and all you’ll need to do is be patient and wait it out. In the stagnation scenario, however, the assumption that the stock market “always recovers within a few years” could be tested. Many people don’t remember that from the year 2000 through the end of 2012, the S&P 500 stock index had no price appreciation for 13 years. It had ups and downs, but at the end of that cycle, the market had actually gone down in price. This isn’t ancient history.
In Europe, they have a stock market index called the Stoxx 600, which is similar to our S&P 500 stock index. Since the year 2000, the Stoxx 600 has had an annualized price return of 0.64% for almost 23 years. Not many investors think modern markets can stagnate for over two decades, but they can.
Investors, however, tend to ignore scenarios where markets may stagnate for long periods. The reason is the odds of it happening are low, and there isn’t much you can do about it. Investors in general are in the same boat, and you just have to deal with it.
But if you are concerned about a cycle where markets stagnate, the main advice we can offer you is to simplify your financial life. You are unlikely to invest your way to riches if the rest of the world is stagnating. But you can do things like pay off your house, get out of debt, and drive your fixed expenses down as low as possible. It takes time, but you can simplify. That way, you’ll be in a much better position to handle this type of scenario than most people.
Alternatively, don’t worry about the stagnating scenario as it’s unlikely to happen. No one can tell you which course is correct. You’ll have to decide that for yourself.
Charlie Farrell is a partner and managing director at Beacon Pointe Advisors LLC. The information contained in this article is for general informational purposes only. Opinions referenced are as of the publication date and may be modified because of changes in the market or economic conditions and may not necessarily come to pass. All investments involve risks, including the loss of principal.
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