Ben Franklin

Ben Franklin

It is certain that diplomat, statesman and founding father Ben Franklin was confronted with many difficult decisions. According to the man himself, “my way is to divide half a sheet of paper by a line into two columns; writing over the one pro and the other con. Then, over three or four days’ consideration, I put down under the different heads short hints of the different motives, that at different time occur to me, for or against that measure… .I find where the balance lies; and if after a day or two of further consideration, nothing new that is of importance occurs on either side, I come to a determination accordingly.” With the above in mind, we thought it appropriate to look at five pros and five cons of investing during these volatile times. We will start with the cons.

In our opinion, the most influential con is the possibility and even likelihood that the fed continues its restrictive monetary policy well past the point of peak inflation, resulting in a more severe contraction than the economy would have otherwise experienced. The Fed has a long history of being a day late and a dollar short in applying the appropriate policies in dealing with economic issues and we can point to, up until the last two months, the rapid increase in money supply. Despite its recognition in December 2021 that it was too accommodative, interest rates remained at or near zero for several months following and the Fed continued to purchase bonds through May 2021, thereby adding fuel to the inflation fire. Now that the Fed has religion we fear that it will remain too restrictive and as a result curb inflation solely through demand destruction should the supply chain remains disrupted.

Con #2) the war in Ukraine, China’s irrational “zero tolerance” policy regarding COVID, logistical (shipping) issues as well as labor shortages result in a much longer than anticipated continuation of global supply chain imbalances, stymieing economic growth. This, despite the Fed’s best efforts, may nonetheless not result in declining inflation — i.e., stagflation, a term to describe suboptimal economic growth accompanied by inflation. This erodes the labor force as well as standards of living.

Con #3) mortgage rates have doubled within the past six months, crushing demand for both new and existing homes, jeopardizing an industry that employs millions, one that is critical to the economy of the United States. As noted last week and assuming a mortgage of $350,000, at an interest rate of 6%, the monthly payment increases $622 or $7,464/year as compared to one year ago when interest rates hovered around three percent.

Con #4) the war in Ukraine expands into NATO countries, the sanctions imposed by the United States and its allies falter or deglobalization continues to gain momentum, the ensuing increased costs inherent will be either borne by the supplier or passed along to the consumer.

Con #5) the technicals (defined as a technique that analyzes past pricing

patterns in order to predict future movements) of the market continue to erode, thereby limiting support for securities at or near current prices.

Whew, now on to the pros.

The first and most obvious pro is that after a twenty-plus percent bear market, most if not all of the above has already been priced in. Investors have priced in a modest recession. They have priced in the current state of the war in Ukraine, COVID, manageable inflation, a slowdown in the housing market and the deterioration of the technicals. This is our base case. In addition, if history is any guide the potential for substantial market returns over the next several years has improved dramatically, especially when compared to the alternatives.

Pro #2) the economy remains strong. Although the strength of future economic growth is open to debate, there is little debate that the current pace of economic growth, although moderating, remains robust and that at worst, the economy is at risk for a brief mid-cycle slowdown, one that may add to the duration of the current economic expansion.

Pro #3) interest rates may be peaking, at least temporarily. Historically, rising interest rates put pressure on equity valuations and therefore prices. Since the close of 2021, the yield on the 2-, 5- and 10-year U.S. Treasury Notes have risen from 0.73%, 1.26% and 1.52% to 3.17%, 3.34% and 3.25%, respectively. This rise has resulted in conservative investors now investigating alternatives other than equities and pushed markets lower.

Pro #4) investor sentiment is very bearish, hovering near its lowest level in 30 years. However, according to the American Association of Individual Investors (AAII), “historically, the S&P 500 index has gone on to realize above-average and abovemedian returns during the six- and 12-month periods following unusually low readings for bullish sentiment.”

Pro #5) this is a mid-cycle election year. According to statistics gathered by U.S. Bank and published on March 4, 2022, the average return of the S&P 500 during the year of the midterm through October 31 was 0.3%. During non-midterm years the rate of return averaged 10.7%. Furthermore, from November 1 of the midterm year through October 31 of the following year the S&P 500 rose by an average of 16.3%. As an aside, please note that during each of the 16 periods following the midterms noted above, the S&P 500 was always higher.

There you have it. Our version of Ben Franklin’s “T” Method for making decisions. Regardless of the method you use for determining your investment policy, keep in mind that over a full economic cycle stocks are the best performing asset class and that your chance to buy low via dollar cost averaging is now.

Please note that all data is for general information purposes only and not meant as specific recommendations. The opinions of the authors are not a recommendation to buy or sell the stock, bond market or any security contained therein. Securities contain risks and fluctuations in principal will occur. Please research any investment thoroughly prior to committing money or consult with your financial advisor. Please note that Fagan Associates, Inc. or related persons buy or sell for itself securities that it also recommends to clients. Consult with your financial advisor prior to making any changes to your portfolio. To contact Fagan Associates, Please call 518-279-1044.