The Rules Have Changed

June 16, 2022  |  Michael Reilly

Earlier in the week, I mentioned a very classic market pattern playing out in the equity indexes. I think it warrants a deeper review. 

Why? Because 2022 is not 2020, or even 2021, or virtually any other year going back a decade… 

Any investor still living under the illusion that we’re in the same investment climate that we’ve enjoyed for the previous 10 years is in for a world of hurt.

The rules have changed.

How many of you out there are having that conversation with your advisor who’s still telling you to “stay the course” because “you’re investing for the long-term”… and all the other bull they’ve been trained to say.

I truly hope there’s a little voice in your head telling you there’s something wrong here…

Markets Cycle with Economic Change 

Markets move from a Basing stage (or Bottoming) to Accumulation when institutions and investors are buying up stocks as prices rise, profiting as they go.

This is happening during times of strong economic growth, solid employment, and accommodative Fed policy.

That stage is over – it’s in the past.

After Accumulation comes the inevitable Topping pattern, where stocks chop sideways and consolidate for a period of time. This can be a pause prior to another move higher OR this is a period of change. 

2022 is a period of change… one that will someday be in a textbook illustrating market cycles.

Take a look at this price chart of the NYSE.

Where are we now? We’re not in the green for go (Accumulation). We’re no longer in the yellow for caution (Topping). That leaves option 3: The flashing red for DISTRIBUTION.

Here’s another version of the same data using big red arrows. See the one on the far right that is heading down? That’s the market taking investor money.

Do you know why it’s called the Distribution phase? 

Because large institutional investors are distributing their stock… TO YOU. 

And they’ll be more than happy to buy it back later… MUCH CHEAPER.

We’re not in the same investment climate we have been in before. 

If you continue to think we are, I’m sorry – you’re likely going to be disillusioned in the end.

2022 Is a Year of Tremendous Change

Let’s play a game… we’ll call it “What’s Changed?”

Interest rates are rising sharply and according to yesterday’s Fed call, they’ll continue to raise rates at a 50-75 bps pace until inflation is under control, which is a long way from today.

The Fed is removing liquidity from the economy to help slow down demand and reduce inflation. Said another way, the Fed isn’t going to fund the market’s rise any longer.

Oh yeah, plus inflation is at 50-year highs

There’s a war in Europe, resulting in an economic slowdown on the continent which may result in recession. We’ll continue to experience further supply-side inflation as wheat and other agricultural products are not getting out of Ukraine.

This means higher prices.

Then there’s China’s zero-COVID policy and associated lock-downs resulting in further delays in getting goods shipped out of the largest port in the world. Again, more supply-side inflation with higher prices for consumers.

Look at these rates! The yield on the 10-Year Treasury is now higher than it was in 2018 (the last time the Fed raised rates) marking the end of the rise of growth assets around the world.

If you’re buying growth stocks here, you’re fighting headwinds in the form of higher interest rates. 

If you own growth stocks here, you’re betting against the Fed – not usually a winning strategy.

Then there are bonds, often considered the safe alternative to stocks. And a big part of the stock/bond asset allocation model pushed by advisors.

Bonds are off to their worst start in history. Safe to say the bond holdings of your typical asset allocation model are getting hit just as hard as some of the stocks. So much for diversification.

And here’s the U.S. Dollar Index. The U.S. Dollar is at its highest level since 2002. 

Here’s the thing about a strong dollar – it’s a market killer. Stocks don’t rise when the dollar is this strong. 

So let’s summarize things…

  • The market cycle is clearly in the Distribution phase. Big investors are selling, not buying. This is not when you take big bets on stocks rising.
  • The Fed is raising interest rates and has no plan to slow down. They’re also removing the fuel that’s propelled stocks higher for years.  
  • And the U.S. dollar is higher now than at any time in the past 20 years. Dollar goes up – Stocks go down.

But your advisor – the person you’re counting on to keep you out of the poor house – is telling you “this is just another bump in the road, we have a long-term plan.” 

You can read that as: Do nothing – old-school buy-and-hold. 

Yep, hold it right to the bottom… and take years to recover.

I’m telling you everything has changed. And if your strategy and allocation to assets do not change, you Mr. and Mrs. Investor, are going to suffer.

Until next time, invest wisely…

P.S. To learn more about Rowe Wealth can help you weather the current turbulent markets, you can schedule a free 1-hour consultation here.

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