The U.S. stock market is coming off its best week since November of 2020, as the dip buyers were back, sending the Nasdaq up more than 8%, the S&P 500 up more than 6%, and the Dow Industrials up 5.5%. This even after the Federal Reserve bumped interest rates up a quarter point and flagged at least six more rate hikes through the balance of the year. The Fed would like to see the overnight lending rate at about 2.4% by the end of 2022. It also predicts inflation will cool down by midyear and fall sharply lower in 2023. A sprang of interest rate hikes will do that to runaway prices. But you know what else brings down high prices? High prices. Consumers pullback when prices stay too high for too long. And we saw signs of that last week when the February retail sales numbers came in lower than expected at just a 0.3% increase from January.
The Fed lowered its forecast for U.S. GDP for the year from 4% to 2.8%. That's a pretty big cut, and the bond market is whistling some warnings. The yield curve is flattening, which is another way of saying that yields on long-term bonds, which are typically higher than short-term bonds, are falling as investors pile money back into them looking for safety. Yields fall as prices rise. As those yields fall, they are approaching the yield on short-term government bonds, which have been rising as investors sense the near-term economic outlook is not so rosy. A flattening yield curve is one thing. An inverted yield curve, when the yield on long-term bonds fall below those of short-term bonds, is a five-alarm fire. Those usually precede recessions. We're not there yet, but pay attention to the bond market. It really runs things around here.
Meet Ryan Detrick
Ryan Detrick, CMT, is the chief market strategist of LPL Financial and a member of the Financial Industry Regulatory Authority & the Securities Investor Protection Corporation. Prior to joining LPL Financial, Mr. Detrick was a senior portfolio manager at Haberer Registered Investment Advisor. Even earlier in his career, he spent more than 10 years at Schaeffer’s Investment Research; during his time as the company’s primary spokesperson, he appeared in several national media outlets, including CNBC, Bloomberg TV, and Fox Business.
What's in This Episode?
Investors are surrounded by walls of worry. We're worried about inflation, we're worried about the war in Ukraine, we're worried about rising interest rates, we're worried about things we don't even know about, but we're worried that we're worried about those things anyway. You know what's a good thing to do when the walls of worry are closing in? Look back at where we've been, how things played out and look for clues about what that might tell us about the future.
Nothing is certain, And as our friend Ryan Detrick, the chief market strategist at LPL Financial, likes to say, with a nod to Mark Twain, 'History doesn't repeat itself, but it often rhymes.' Ryan is back on the Express with us this week with a little dose of perspective. Thanks for joining us in the middle of March Madness, Ryan.
"Honored to be here. Thanks for being flexible with me on when we could get this done. And I'm not even sure if Mark Twain really said that. It's like he gets all the cool quotes, him and Paton and those guys. But I love that quote, I love looking at history, and it'll be fun getting to talk to you today on the podcast. Can't wait!"
"Good to have you here, Ryan. The stock market feels pretty irrational lately. It feels like it's trading off of headlines. Sentiment is sour. Fund managers are holding more and more cash. Is that right? Or is this a pattern we've seen before during other periods of uncertainty? Am I making this up?"
"Well, it does feel a little different this time. They say the four most dangerous words: 'this time it's different,' right? Sir John Templeton. But I believe there's a lot of ways you can go with the answer this question, to be honest, but let's go with this: We knew coming into this year, Caleb, that it was a midterm year. Historically, midterm years see a 17% peak-to-trough correction, the most volatile out of the four year cycle. If you're willing to hold those lows (and I'll admit, no one knows when the lows are), a year later, you're over 30%. We also knew the economic cycle was aging. We knew the Fed was going to start hiking interest rates. Remember, back in 2015, early 2016, when they started hiking rates, that wasn't the best time for the market until it found its footing."
"So, we knew some of these things... oh, and by the way, last year only had a 5.2% peak-to-trough correction on the S&P, as most people remember. You look at history, you usually have a rockier year the next year. So, we knew all those things coming in. LPL research, we've got a 5,000 year value target of the S&P. Still, anything can happen. This is kind of like a long way away, but the bounce this week makes it a little bit easier. But still, we would have said, 'Hey, the chance of a 10% or 15% correction this year in 2022 was really strong,' and we expected to see that. We think it happened in the first month of the year or second month of the year. Well, maybe not. But again, we knew all that coming in, and now here we are."
"And again, they also say, right, 'Stock markets are the only place things go on sale, everyone runs out of the store screaming.' Headlines have been super scary. Bad, bad stuff's happening, yes, but it sure felt like things are on sale and people are pretty scared. Maybe once again, history will repeat itself, and I get to come on with you another six or nine months from now or so, and I think we'll be a good deal higher."
"Yeah. Well, you did talk about a potential correction earlier in the year, I think at the end of 2021/ Your notes were all over that. But you've been writing about these big one-day gains we've seen really in the past week or two here. These big bounces that we're seeing, even though they fade a little bit, these are the kinds of strong bounces, Ryan, that are prevalent kind of at market bottoms. Take us inside history on this one. How common is it for us to see these big 1%, 2%, or 3% swings in a day to the upside after a long period of just downdraft?"
"The way we see Caleb is this: When you have a one day bounce of 1%, 2%, 3% or so? That's normal. And I mean, even like in 2008, right? We saw like more 3–4% gains that year than like any year other than the Great Depression. I've had some really bad days amongst that too. It's when you get some follow through, when you get continued strength. So, as we're recording this, right? We had three straight 1% gains on the S&P 500 on Tuesday, Wednesday, Thursday. That's pretty rare to see three consecutive gains of at least 1%, actually up almost 6%. All those three days total. But when I went back 20 years, I found there were only 10 other times when the S&P gained 1% three consecutive days. One year later, S&P was higher every single time. Ten for 10, with a 25% average."
"I mean, so my take is this: This blast of strength that we've just seen this year is not the hallmark of the end of a bullish move or kind of the middle of a bullish move. I know it sounds crazy. It's almost the hallmark to the start of a new bullish move. The last two times we saw it: the election in 2020 and March in 2020. Two pretty good times to look to buy the scare and buy the fear and which eventually obviously result higher. And we'll see where this one goes. But this blast of strength is usually a sign of... you probably want to be long, I guess is the best way to put it, for next six to 12 months."
"Trend watchers, market technicians, or both of those things, they call these periods of consolidation, periods of foundation forming, right? We're laying the foundation for potentially higher gains. At the same time, we know what's coming our way, right? The Fed has pretty much mapped out the next six interest rate hikes for the rest of the year. They want to see the Fed funds rate back up to 2.4%, where it was pre-pandemic. That's obviously throwing the big chill over the stock market, particularly tech stocks, but rate hikes are not necessarily the kryptonite that everyone thinks they are. Are they, Ryan?"
"No, they're not. And again, it's like most of us... there are a lot of people who are doing this for the last 10 years or so. They haven't really seen too many cycles of rate hikes, right? The way we look at it at LPL Research is this: When the Fed starts hiking, you're probably more mid-cycle, meaning there's probably years left of an economic gain or a stock market gain. I know that sounds kind of weird, but when you break it down, it actually is the way it is. We looked at the last seven times the Fed did the first hike and a new cycle. One year later, S&P was higher six of those times. Right? I mean, it was some pretty solid gains. We also saw, after you do that first hike, Caleb, the stock market has a peak for almost three and a half years later, on average."
"Believe me, there's lots of stuff swirling out there. I get it. But just to blindly say, 'Oh, my God, the Fed is hiking rates. Let's go sell everything and buy gold and hide under the bed.' That's not kinda how this works. And again, there's some reasons they're hiking, right? The economy is finally standing on two feet. We've got 40 year inflation. They need to hike to try to combat some of these things. So, you could say, 'Is this time different?' I get that all the time. This time is different because we got a lot of inflation. So, yeah, it is. We've never seen the Fed hiking rates with the yield curve this flat, right? I mean, it's never happened before. So, there are some somethings in there."
"But at the same time to blindly say the Fed hiking is bad... it's not true, right? And again, maybe it means there's still more time to go, and we can talk about the economy and stuff. I'll just leave it at this: Earnings expectations this year are actually up 3%. S&P 500 earnings expectations for 2022 are up 3%. Might not sound like a lot, but when you see all the stuff that's happened this year, that's pretty impressive. So, earnings continue to drive long-term stock gains, and corporate America is still pretty optimistic about the future. I know what the consumer confidence numbers always say, but what are the consumers doing, right? They're saying one thing, but they're doing another. And the economy still looks pretty healthy to us, and that means we probably don't see a recession for a couple more years, at least."
Today, recessions are characterized as steep declines in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale retail sales. Since World War II, there have been 13 recessions in the United States. That's one every six years on average.
"Yeah, retail sales slid off a little bit in the past month. Prices were high. We're also coming out of the holiday, so people are regrouping. But you're right, we keep spending our way through whatever comes our way. That's what U.S. consumers do. It's our favorite sport. We do see a little bit of a dent into credit. You see a little bit of a dent into household savings. We're not where we were last year, but the personal savings rate was through the roof because of those government distributions out to folks. So, consumers seem to be hanging in there, but I guess the worry, and I guess you hear it all the time from your advisors and the people you talk to, is that, 'Hey, they're going to hike too fast. They're going to cool down borrowing costs so much. No one's going to want to buy a car, put a mortgage payment down, businesses aren't going to want to spend on CapEx.' How serious do you think those concerns are?
"Yeah. I mean, they're very real concerns. There's no doubt about it. At the same time, I say like this, we're a little skeptical that we're going to see six or seven hikes this year. We're more in the four or five camp. Nonetheless, that's a good amount of hikes. Just remember this, though, if you look back in history, in 2004, 2005, 2006, right? Those three years, the Fed hiked 17 total times. The S&P was higher every single year, all three of those years. Not massively higher but was still higher, right? I mean, still some solid gains."
"So, again, we've got the same concerns as everybody else. Is the Fed behind the eight ball? Are they going to hike too far too fast? All the geopolitical concerns. What's going to happen with China and Taiwan? I mean, we get paid to worry... the stewards of assets, and those are clearly some of the some of the very valid, valid concerns. But you think about this year, right? I mean, we just had a 50th trading day of the year earlier this week, maybe Monday or Tuesday, I'm not 100% sure, but 50 trading day of the year. This is the sixth-worst start to a year ever for the S&P 500. Someone might hear that and it's like, 'Oh, my God, that doesn't sound good,' and it doesn't sound good. But then you look at the other five worst times, the rest of the year was higher. Thirty five percent on average, only once was the rest of the year down, and it was barely down. It was in 2001 in a recession year."
"So, we've had some massive bounces back. 2009, 2020, some of the recent ones, 82s' in there. Terrible starts to a year, and it can snap back. So, I know all this bad stuff out there, but I always like to say the market is a forward-looking mechanism that's pricing bad stuff and/or good stuff, for that matter. And there's been a lot of bad stuff that's priced in. And any good news at all... look at the bounce we've seen this week. And my God, we really didn't have that great a news this week. Headlines overseas are still pretty terrible. If you ask me if the Fed's hiking, I don't know. It sounded pretty hawkish on Wednesday, but it wasn't the end of the world, and the market had this rip-roaring best week it's had all year. So, there's probably a little more fuel in the tank. When you look at that Global Fund Manager Survey that Bank of America does, almost 6% cash, what in the world does that mean? Well, that's like the highest since the pandemic, right? There really is, cliche to say, money on the sidelines. There really is some money on the sidelines with the rough start to the year we've seen. But previous rough start to a year? They've seen some pretty good sized bounces, and we wouldn't want to bet against that this time.
According to Bank of America's recent Global Fund Manager Survey, sentiment is bearish. Cash levels, economic projections, and profit expectations are also recessionary, but their equity allocations are not. So, while fund managers fear the worst, they're not scared enough to capitulate and get out of their stock positions completely. That could keep some support under the market if it tumbles again.
"That's, folks, why we stay invested, and that's why we talk to Ryan Detrick. We need that perspective, otherwise it's really easy to lose your head in a market like this. Ryan, energy and financials have been really the market leaders all year. Really energy for obvious reasons, right? Rising commodity prices and higher interest rates on the way. Is there any reason to think that dynamic will change throughout the rest of the year?"
"I mean, we've liked cyclical value for a while, so we've we've been OK with energy and financials leading. We still like that group. I mean, let's be honest, some of the moves we've seen in commodities, specifically in energy, it is extreme. So, that rubber band is stretched far. So, maybe there can be some consolidation or a little pullback. But I'll tell you, if there's a pullback, we think energy's a group someone should strongly consider. I believe, as of recently, energy makes up about 3% of the S&P 500. So, not much. Financials are a bigger chunk, but you don't have exposure to those two, and you're just sitting in the tech names or FAANG names that did so well for so long. And obviously, you're looking at the world a lot differently than someone who has a diversified portfolio sticking with cyclical values."
"So, we'd say stick with who brought you to the party. We're still a little bit overweight cyclical value in the models that we run for our nearly 20,000 LPL advisors, and we think it makes sense. I mean, yields are going higher. I know the yield curve's flattening, but still there are some positive things taking place with the consumer, so banks still do pretty well. And regional banks, insurance, some of these groups have been really... broker dealers... have been really strong. It's the big money managers, the big names you've heard... no one love or maybe don't love, in some cases, that have struggled. But in financials, there really are some strong names there, and we do that very well if we continue. So, we'd stick with those areas."
"Now tech... the big question I get is, What do you think about tech,' right? I mean, we're more neutral tech. There's 11 S&P 500 sectors. We rank tech about six. So, we don't hate it, we don't love it. Now, let's be honest, given the pullback we've seen... Nasdaq was in a bear market for like a minute earlier this week until the rip-roaring rally. There's probably some solid opportunities in some particular companies, but we're more neutral on tech because we think rates probably trickle a little bit higher still, and that could impact technology in general. So, we still like value a little bit over growth, leaning toward cyclical value."
"You anticipated my question because a lot of investors, including our readers, they didn't rotate out of growth necessarily at the end of 2021. They just kept feeding their retirement or brokerage accounts. Or maybe they just held back because they were worried. But keeping that money pouring into index funds, into the big ETFs, that are all tilted towards growth because that's where they're all tilted, right? Do you advise they rotate now or wait for the cycle to tilt back from value to growth? Are we in this low kind of grinding gear for a while, maybe second, third gear? We're going to produce some gains, but we know rates are rising, and it's just going to be a slow grind higher."
"Yeah. I mean, that's the ultimate question, right? If you missed a move, do you do it now? Do you wait? I mean, I like the idea of dollar-cost averaging, it's not quite what we're talking about here, but maybe move a little bit to the value now and then there might be a bounce. Honestly, you look at value growth right now, I mean, values really beat growth. So, maybe it's time for growth to have a little bit of a pop. I guess my take, it might be more like a bear market type of a pop here, but I think end of the day, the models we run, we're like maybe 53% value, 47% growth. We're not saying make a big swing almost either way, although we would tilt toward the value side like I just talked about, but I think having a more balanced portfolio right here and now, this point of the cycle, does make a good deal of sense."
"And then, the whole all idea about bonds, I won't get into that. I mean, this has been a rough year for stocks. It's been a really, really rough year for fixed income and bonds on the heels of another rough, rough one for bonds. So, someone who has a diversified portfolio, you're not getting that safety net or at least the gains that you usually saw on fixed income that you tend to see when the stock market sells off. But we'd still stick with owning a little bit of bonds or overweight stocks, or else with the bonds are getting overweight a tad on the value side. But it's a very interesting year when you look around and it's like, 'If you didn't have commodities, you're probably not feeling pretty good.' I don't know. That's that's that's just the way it is this year."
"Right. In the 60/40 portfolio, which was really tried and true for so many years, has not performed the last couple of years cause bond investors have really not had a good time throughout these cycles. Is there any reason that should change or are we just facing a new dynamic where you got to pick your sector, and if you're looking for safety, if you're looking for a more conservative trade, it's not necessarily going to be in bonds. It might be in a different part of the stock market, which traditionally you don't pay attention to."
"Yeah. Well, the thing about... that's a great question there. When you think about bonds, I mean, most people just think Treasuries or Barclays' AGG. I mean, there's different parts to the bond market just like there are different parts of the stock market. And we really like bank loans. We think, potentially, junk high yield right now for the beat up that they've had, though, there are some there's some potential good values there."
"The truth is this, right? Stocks are pricey coming into this year, I should have mentioned that... coming into this year, we knew stocks were priced, and we knew that, right? That doesn't mean it couldn't keep going up. But I mean, stocks are pricey. Bonds are really, really pricey historically. And you see the 10-year yield... I'm not exactly sure where we are in the U.S. We'll just say 220, I think it's pretty close right now. But then you got Germany, less than half a percent, and Japan down around that area. Even though our yields feel low to us, that's a lot to the rest of the world that have even lower yields. So, there's still, I think, a lot of demand for our fixed income and our our juicy 2.2% percent yield with our 10 year."
"I totally get that. What's the greatest risk out there for individual investors, Ryan, that no one's really talking about?"
"I know the way I answered this is the start of the year, and I still think it's true. I think U.S.-China relations, and I know we've got some other geopolitical concerns that have popped up. But the truth is, when President Biden won, most people thought U.S. and China relations would become better. Maybe some of those tariffs would come off, and that hasn't happened at all, right? And now everything that's going on in Ukraine, is China going to help Russia, and whose team are they on, or what's going to happen here? I'm not saying I'm staying up at night thinking about it, but I think that's one thing investors need to be aware of."
"And then you see the whole, 'We're going to delist Chinese names,' and Chinese stock market was killed, and then we had the enormous rally in China a couple days ago. But that's the one that gets me cause we all remember 2018 when the tariffs, back I guess February 2018, what we slapped on the tariffs on washing machines. That was a major, major structural peak for stocks for a long time. Not saying another trade war's coming. I'm just saying when the U.S. and China don't get along like they did in 2018, that wasn't always a good thing for investors."
"On the other side, Ryan, what's the greatest opportunity for an individual investors that no one's really talking about right now?"
"I still think financials. So, I look at a lot of financial stocks, OK? And they've had a run... they're like where they were in 2008. We all know technologies had this great run, communications have this great run. Those are stretched. And then you look at these bigger picture charts and things like financials... I almost forgot energy. I know energy's had this huge run, but on a relative basis, energy stocks relative to tech stocks or some other parts of the market, it's just this little blip of outperformance."
"So, there really could, in our opinion, there could be a lot more outperformance. I'm not talking just for a year or two. I'm talking these major cycles that we tend to see for five or 10 years where finally, believe me, I know it's been rough, where finally some of value names could start to do well. And don't forget in 2000, 2001, 2002, three-year bear market. Now, that's not our call. But three-year bear market, financials and value did pretty well. So, when the tech comes down and the growth comes back, money is going to go somewhere. So, I think the opportunity to realize that these cycles can last a while, that's really important. And I think that's a place people can do well for, hopefully, several, several more years."
"Yeah. To your point, there's a bear market happening somewhere all the time. Usually there's a bull market happening somewhere all the time. You got to know where these things are happening, or you could just spread the risk out a little bit (dollar-cost average, as you mentioned), and protect yourself no matter what happens, because a lot of us can't follow it as closely as you can. Ryan, you're such an astute observer of the market. Such a great market historian, a technician, and so good at explaining it. You know our site is built on investing terms. What's your favorite investing term, Ryan, and why?"
"You kind of just said it. I was thinking that... dollar-cost averaging, I mean, who really did well the last couple of years when it came to investing? It was the person who was just putting money in their 401(k) every two weeks and didn't... they might have been scared, I mean, there's a lot of scary stuff, but the ones who didn't panic, they kind of used the opportunity when things came down and they made good investment decisions by continuing to invest every couple weeks."
"I mean, the dollar-cost average is such a powerful thing because you just talked about, you asked me, I don't know, three, four questions ago, 'What should you do right now?' It's so hard when the market pulls back a bunch because the way our brains are wired is, 'Go all in.' I could have told you there'd been a 15% correction this year. We thought there probably would be, and then, 'Boom, here it is.' And everyone's kind of scared of that. But just be aware you could put a little in, a little in, a little in. You don't have to always be making all-in and all-out types of trades, right? It's the old, 'Swing for singles and doubles.' It sounds cliche, but again, it just kind of helps long-term investors reach their goal."
"Singles and doubles. You rack up enough of those, you'll wind up in the Hall of Fame, like so many good players have done over the years. You swing for the fences, you're going to get a lot of strikeouts. Ryan Detrick, so good to have you back on the show, so appreciate your perspective. I follow your stuff all the time. Folks, follow Ryan Detrick and the LPL Financial crew on LPL Financial, but also Ryan on Twitter. Such a good follow, and I love your newsletter. Makes so much sense to me. Every day makes me feel better. Thanks for coming back on the Express, my friend.
"No, any time. lplresearch.com is our blog of a podcast, LPL Market Signals, just @RyanDetrick. Those are three ways to follow along the crazy, crazy world that we have. But Caleb, thank you for having me. Big fan of everything you do and all the way you've helped so many investors and people over... I don't know, I don't want to make you sound old, but over the course of a long time. I know you... we've known each other for a while, so thanks a lot for having me on, and maybe let's go watch some basketball."
Term of the Week: Moral Hazard
It's terminology time. Time for us to get smart with the investing and finance term we need to know this week. And this week's term comes to us from Hazel in Southampton, New Jersey, in lovely Burlington County. Hazel suggests moral hazard this week, and we like that term because it has a lot of different applications. According to my favorite website, moral hazard is defined as the risk that a party has not entered into a contract in good faith or has provided misleading information about its assets, its liabilities, or its credit capacity. In addition, moral hazard may also mean that a party has an incentive to take unusual risks in a desperate attempt to earn a profit before the contract settles.
Moral hazards can happen any time two parties enter into an agreement. Each party in a contract may have the opportunity to gain from acting contrary to the principles laid out by the agreement, which is the moral hazard. But moral hazard can also be applied to the extraordinary monetary policy measures, if you can call them that, that the Federal Reserve used in the Great Financial Crisis when it bailed out Wall Street banks. It loaned tens of billions of dollars to many of those banks that had over-gorged themselves on subprime loans and credit default swaps. When the bottom dropped out, their balance sheets caved like an avalanche, threatening to bury them in debt. By bailing them out, many accused the Fed of removing the moral hazard from those banks. The theory being that the banks would behave badly again, knowing that the Fed wouldn't let them collapse. Good suggestion Hazel in Southampton, New Jersey. We're sending you a pair of Investopedia's favorite socks for your next stroll in the neighborhood.