3 Reasons Stocks Will Fall

A little bit Investing, A little bit personal

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Seeing as this week marks the end of the month, I’m going to throw the running order out the window a bit.

Today I want to give my take on where the stock market is headed in the coming months and what this all means for your portfolio.

I’ll be back with more personal ramblings next week 😊

I'm always happy to chat all things investing so send me your thoughts [email protected]

1 Random Thought 

Early in my career, I thought I knew it all. About two years into studying all things investing, I genuinely believed I wasn't too far away from solving the market

'Investing? Completed it mate.

A decade, and endless hours of research later, I still haven't cracked it.

I simply didn't know what I didn't know.

It's like that meme of a guy reaching the top of a hill only to realise a much larger mountain lay hidden from view the whole time.

There is a psychological term for it. It's called the 'Dunning-Kruger effect'.

(I found some comfort in this because if there is an entire phycological theory about it, surely I'm not the only gullible idiot to fall into the trap.)

The Dunning-Kruger Effect occurs when a person's lack of knowledge and skills in a specific area causes them to overestimate their own competence.

There is a whole cognitive journey that we go on.

1. Early over-confidence

2. A 'valley of despair' where you finally realise everything you don't know.

3. A slow climb out of the gutter aided by years of experience

Depending on the stage of your career, there is likely a huge chasm between how much you think you know and how much you actually know.

At least, this was the case for me.

The Dunning-Kruger Effect 

The moral of the story. Confidence and competence are not always directly correlated.

Beware of anyone who is overly confident in their assertions. Maybe they are correct, or maybe they just don’t know what they don’t know yet.

This is true for every field, but it is especially dangerous in investing (and open-heart surgery).

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3 Things That Could Send Stocks Lower

I can’t recall a time in my career when the outlook was so ‘uncertain.’

I write to clarify my thoughts on the market, but right now, the market noise is deafening.

Soft-landing, no-landing, zero-gravity economy, inflation woes, the lag effect of interest rate hikes, monetary tightening, slowing growth, relentless labour markets, falling earnings and more money in the system than ever before….

Pick a few data points and construct whatever narrative you like.

For me, the economic data points to an obvious slowdown, so my head screams ‘LIMITED UPSIDE,’ but my pocket tells me I have been wrong plenty of times before.

The slowing economic data is irrefutable, but using it to discern an exact timeline for the stock market is close to impossible

And in this game, being early is the same as being wrong.

Ultimately my medium-term view can be condensed to;

With a risk-free rate of 5%, stocks offer more downside than upside. Long-lasting bull markets require rapidly expanding valuations and/or strong earnings growth. I don’t see evidence of either in the data.

But this view is contingent on some specific data points.

Here are 3 areas I am watching that will dictate where the market goes over the coming months.

1.Property

Ultimately housing is the economy. In the U.S., housing makes up 15-20% of annual GDP.

In Ireland, household wealth has soared to 1 Trillion euros. 649 Billion of that was held in property.

You need to pay attention when housing moves a lot in one direction.

Housing data has turned very negative in recent months. Some of the data is shockingly bad.

Existing-home sales have been falling for twelve months straight. January year-over-year sales were down 36.9% and are now at levels last seen during the COVID low and Great Financial Crisis.

The pipeline isn’t looking much better. Mortgage application rates have hit 28 year lows. 

Clearly, the stand-off between buyers and sellers is continuing, but with the extreme drop-off in existing home sales, a pullback in prices seems reasonable.

we have already seen house prices fall, but not by all that much, given that prices soared over 40% in the 18 months from 2020 to June 2022.

Signs of Improvement

Recently there has been some data suggesting that the market may be bottoming.

A huge monthly gain in pending home sales last month has help turn the year-over-year trend around. That said, sales are still down by 22% over the prior year.

US pending home sales

While this is a positive development, the recent favourable data is likley due to the brief drop in 30-year mortgage rate we say between November and February. As mortgage rates climb back to 7%, conditions will tighten once more.

Outlook

Housing affordability is nowhere near where it needs to be for demand to return.

We need either a big adjustment lower in interest rates, a big decline in prices or some combination of the two.

If the Fed are forced to stay ‘higher-for-longer', Mortgage rates will remain elevated, and prices will be forced to adjust accordingly. A limitation in supply will put a floor on how low prices will go, but there is still further to fall.

2.Interest Rates

Economic data has been better than expected, and markets are busy trying to digest what this means for the Fed.

For the past ten months, the consensus has expected a slowdown in the labour market, but every month the data has come in better than expected.

One reason for this is corporations are holding more long-term fixed-rate debt. The average maturity of bonds issued by S&P 500 companies is 11 years today. Favourable rates have already been locked in, keeping the overall cost of servicing their debt low and helping companies weather an economic slowdown for now.

However, there are some pitfalls to consider.

1. Interest rate hikes work on a lag. The impact of these interest rate hikes are not fully known until 18 months to 2 years later. Labour market conditions have yet to be fully impacted by the 2022 rate hiking cycle and could continue to decline long after the Fed stops hiking rates.

    

2. The data used to determine labour market participation is questionable. If you look at the 'full-time' employment data, the pace of hiring is slowing rapidly.

You can view all this in multiple ways, but for me, a resilient labour market will force the Fed to stay higher for longer. These higher interest rates act as a chokehold on the business cycle, ultimately deepening the economic slowdown and increasing the probability of something breaking

3.Savings Rates

The personal savings rate in the U.S dropped to 2.3% as of October, down from 7.3% a year earlier. It’s the lowest since July 2005, when the rate hit a record low of 2.1%.

U.S Personal Savings Rate

All is not lost, there has been signs that the savings rate has stabilised in recent months.

The U.S Personal savings rate climbed to 4.7% in January 2023.

A Positive Pick Up In Savings Rate In January

Despite the recent stabilisation, the trend is clear.

The story goes something like this:

• In 2019, our savings rate was in and around the average rate of 10%

• Then, a pandemic came along, forcing us to be locked indoors for a few years while the government sent out cheques and cut interest rates. This pushed savings rates to above 30%

• Once the world opened up again, we all ran outside to spend our newfound wealth, resulting in a surge in prices and the highest inflation in 40 years.

• We continued to spend regardless of inflation thanks to our pandemic savings, but as our accounts dwindle, inflation becomes a much more precarious beast.

If your bank account is increasing rapidly even after adjusting for inflation, you are more likely to spend and hence boost economic activity later on.

If inflation is running wild and the cost of getting a loan is becoming more expensive, your bank account is likely to flatline, and so is your contribution to economic activity.

Extremely low savings rate = slower economy

With that said, you can't define the entire global consumer using a single data point (oh, how I wish it were that simple)

Delinquency rates and Household debt to GPD ratios have climbed slightly higher but still remain at low levels, so it's not all bad.

I will need to see more data before a full call can be made on this one, but the trend is less than convincing.

What does this mean for your portfolio?

1. With a risk-free rate of 5%. There is absolutely no reason to have idle money sitting in a deposit account. 20X your return by moving into short-duration fixed income.

    

2. Long-duration bonds offer less yield but offer true diversification if and when markets turn and rates fall. These should be considered.

    

3. We are likely to see some short-lived market rallies as inflation pressure subsides. These will run out of steam over the medium term. No signs of a long-term bull market just yet.

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