THE RATIONAL INVESTOR: Are the good times over for the economy and stocks?
Investors are mired in uncertainty, befuddled by what to expect over the near future from the economy and the stock market. Many professional economists and advisers are just as befuddled. Thus, it’s timely to review what we know and don’t know and the likely impact of these.
We know inflation running at 8.6% is the highest in 40 years. We don’t know what inflation will be. However, it’s almost certain that once the current bout of inflation works its way through the economy, inflation will trend down. My scenario: Inflation won’t get anywhere near the Fed's 2% target for some time; it will fall to 3.5% to 4.5% in the next year or two. This will be mainly due to delayed rising wages and the impact of the Ukraine war. Additionally, supply chain disruptions and COVID-19 will add to cost pressures.
These will cause the Fed to continue increasing interest rates beyond the current 1.5%-1.75%. They have already indicated another .75 percentage point is coming and after that perhaps another of .5 or .75 percentage points. My scenario: The Fed will continue to raise interest rates until they about match inflation.
Rising interest rates will cause the economy to slow, corporate profit growth to decline and unemployment to increase. My scenario: The Fed will become more cautious as they occur. They’ll adjust the rate of increase of interest rates as required to minimize the chances of a severe recession. They will be largely successful and perhaps barely avoid a recession or more likely engineer a shallow one.
COVID-19 is still a problem. While the death rate has fallen, we are seeing rising infections. My scenario: COVID-19 will remain a problem with a spike with wintry weather. This will continue to disrupt supply chains, not only in the U.S. but in China, which supplies many goods that we take for granted.
The Ukraine war is having a significant impact on energy prices and food scarcity due to sanctions on Russia and Russia’s blockade of Ukrainian grain shipping ports. My scenario: This will continue into 2023 and pressure prices for oil, natural gas, and grain. The greatest uncertainty is if the war will spread. My crystal ball is cloudy about this. However, if it spreads, all bets are off, and my scenarios will be meaningless.
Let’s look more closely at the impact of all the preceding on potential market returns.
Increasing interest rates will pressure stock prices as bonds become more competitive with stocks. Stocks are not likely to have a sustained rally until the Fed signals it’s about finished raising rates or starts to lower them. This will likely lead to returns that disappoint investors. For example, the 2022 return of the classic 60/40 portfolio was recently about -16%. With the pressure of rising interest rates on bond and stock prices, falling corporate profits and likely falling investor confidence, it’s difficult to foresee a rosy short-term future for investors. One mitigating factor is that the S&P 500 P/E was recently around 16, close to its median. This could mitigate any stock price declines.
All data and forecasts are for illustrative purposes only and not an inducement to buy or sell any security. Past performance is not indicative of future results. If you have a financial issue that you would like to see discussed in this column or have other comments or questions, Robert Stepleman can be reached c/o Dow Wealth Management, 8205 Nature’s Way, Lakewood Ranch, FL 34202 or at rsstepl@tampabay.rr.com. He offers advisory services through Bolton Global Asset Management, an SEC-registered investment adviser and is associated Dow Wealth Management, LLC.
This article originally appeared on Sarasota Herald-Tribune: ROBERT STEPLEMAN: Short-term future for investors mired in uncertainty
