This April marks the one-year anniversary of the market trough of 2020.
The official numbers suggest that we were in what is called a bear market (or market decline of +20%) for just a month. The financial markets experienced the fastest recovery on record, but that recovery most certainly did not feel like a sure thing, nor did it come in a predictable, steady way.
We often say that staying the course is one of the key principles of investing. Just how important is maintaining that discipline?
Last year, taking a break from U.S. stocks for just a week during the eye of the storm would have meant that you missed about 30% of the subsequent return.
Based on the total return of Morningstar’s US Small Value TR and US Large Growth TR indices. Past performance is not a guarantee of future results. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio.
That would have been an easy week to convince yourself to get out. Fear and uncertainty peaked, and we did not know how long the COVID-19 pandemic lockdowns would last or when/if we would get a single viable vaccine (let alone multiple) — the list of fears could get very long. However, the bottom line is that disciplined investors were rewarded for bearing the extreme uncertainty we experienced in March 2020.
In fact, today we find ourselves in a much different environment. The U.S. market is back to hitting all-time highs. With an additional $1.9 trillion of stimulus being poured into the U.S. economy — and potentially more spending targeted towards infrastructure on the way — investors are concerned about the economy overheating, and inflation fears have taken center stage.
Will inflation rise in 2021?
Financial market news doesn’t sell if there’s not something to worry about, but this feels like a better problem to have than last year. To be clear, I am not dismissing the inflation concerns, because they may well have merit, but I think it’s important to maintain perspective on a few things:
1. Inflation is different from hyperinflation
The first thing that pops into many investors’ minds when they think about inflation is the 1970s — a time when the U.S. economy experienced high inflation of 10% or more. There are many structural differences in our economy today (e.g. an aging population, less labor supply, power and technological advances driving down price levels). Additionally, over the last decade, the Fed has struggled to get inflation above 2%, so getting any inflation may seem like a big change. By way of example, 3% inflation would be a ~50% increase and seems high compared to our recent experience, but a 3% inflation level was in fact the target inflation number for the Fed for many years.
2. The Fed has tools to combat inflation
If the Fed sees that inflation is consistently running above the long-term average of 2%, they will likely raise rates. The concern is that the Fed is discounting how high inflation could get, but if you look at the actual consumer price inflation number for March, it was 2.6%.1 A large contributor to the uptick over the last 12 months was energy, with oil prices rising from an extreme low point from last year (recall that we had negative energy futures prices in April).
While supply chain disruption due to the pandemic could have an impact on inflation, unemployment is still well-above pre-pandemic levels and the economy is still recovering, which makes it less likely the Fed will take preemptive action.
3. Stocks historically provide a hedge against inflation
Let’s assume that we do get higher inflation than what we experienced over the last decade. How is your portfolio positioned to withstand a higher inflationary environment?
The fact that you are invested is your first line of defense; leaving money in cash on the sidelines – beyond what you may need as “cash reserve” – means that you lose purchasing power over time because that money isn’t earning anything. Second, having a healthy allocation to stocks is important because stocks historically have provided strong real returns that exceed inflation.
Managing uncertainty
A year after the market trough, we find ourselves asking some very different questions about what the future holds. The one thread that remains constant is uncertainty. Learning to live with this uncertainty is an important part of achieving a successful investment experience.
Whether you’re concerned about inflation, meeting your financial goals or putting together a successful investment strategy, we can help. Contact an advisor at Wipfli Financial to get started.
Related content:
Turning the page? Market reflections for first quarter 2021
The unfortunate “gamification” of investing
5 things to consider when reviewing your investment portfolio
