August 21, 2023
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Q2 2023 Update – What a difference a year makes!
Second Quarter and YTD Market Returns
- Vanguard Total Stock Market (VTSAX)
- 17% YTD, Q2 8.41%
- All Country World Index (ACWI)
- 18% YTD, Q2 6.32%
- Aggregate Bond Market (AGG)
- 26% YTD, Q2 -0.94%
*Data provided by Y-Charts
**Our prior equity benchmark the Wilshire 5000 has stopped reporting and we are now using the Vanguard Total Stock Market (VTSAX) as a primary look at the full US equity markets. The All Country World Index (ACWI) provides a better look for full equity investors that have some international exposure built into diversification.
12 Month Rewind
12 months ago the economy had just finished a ‘technical’ recession with 2 quarters of negative GDP growth. 2022 was a terrible year as the shock of higher interest rates and fears of runaway inflation ruled emotions. We wrote extensively about the situation 1 year ago and if you want to fact-check our stance…please go re-read what we thought during the storm: link to Q2 2022 update.
At that time we wrote the following:
Looks like the market may continue to struggle for a bit longer against a backdrop of higher inflation, higher rates, and increasing unemployment. Is this a recession or not has dominated many of the headlines. As long-term investors, it really should not make a huge difference. Recessions come and go over time and are a necessary part of long-term investing. Historically they last about 11 months with some closer to 6 months and others, like 2008, lasting 18 months. The economy has certainly slowed from its stimulus-induced highs …as everyone should have expected. Recession or not, we certainly expected a 6-12 month cool-down period after an incredible market run-up. Even with the economy slowing slightly, most companies have continued to report solid corporate profits. In the end, corporate profits drive long-term stock growth and we remain pleasantly surprised at what we have seen.
We do not own any crystal ball, but I like to think we have a load of common sense! Human emotion can only rule the day for so long before fundamentals must return. We are not in some wishy-washy business of throwing spaghetti at the wall and hoping it sticks. We are not trying to find a hot stock or time some flashy narrative. In the end…the markets are often a basic math game. As an owner of a company, you have the right to profit. If those profits continue, then it’s just a matter of time before you are rewarded. Sometimes emotions can cause that time to be longer than desired but eventually, profits will win out.
Fear and Greed vs. Fundamentals
Often market opportunity or caution is simply an equation between fear and greed compared to the fundamentals of profit. Successful investors realize when the pendulum has swung to fear and capitalize by buying more equities. When the pendulum swings to greed they take more profits. Most of the time the pendulum is in between and it is best to simply remain balanced following your own defined risk parameters specific to your plan.
The above volatility index referred to as the VIX is our primary gauge of the fear present within the markets. You can see 2 very clear disconnects of fear that happened in 2008/2009 and 2020. These represented so much fear that the recipe for success was simple…lack emotion and use a huge amount of common sense. Much easier said than done! In 2008 the financial system was melting down and the question was not about companies or specific profits so much as a very binary outcome decision. Would we still have a financial system 10 years later or not? If not, then what would the world look like? Would anything be of value if the whole system kept melting down? What good would cash at the bank be if you couldn’t even access the cash, to begin with? If the government did not step in then the whole world melts down, deposits would be frozen and everything might be worthless for a time. So what good was moving to cash anyways going to be 10 years after the 2008 panic? Diversification provided very little benefit long term as all risks became the same …only 1 of 2 things was likely to happen for almost all asset classes:
- Everything will melt down
- Somehow the system works out and it all will shoot through the moon back to normal
When investing becomes binary…the opportunities are endless! Human behavior is always trending to binary thinking. It wants to think in terms of all winning or all losing and so the market thought is always trending slowly to these extremes to some degree. The major opportunities are when human emotion goes to the all-fear point of a binary outcome set. Fast forward to 2020 and a worldwide pandemic. The same human behavior was at work pushing fear upon markets to an all-time high and with very good reason I may add. Forced and unforced shutdowns of businesses across the globe were going to have massive consequences…maybe even depression-like consequences. The decision was very similar:
- Everything will melt down
- Somehow the system works out and it all will shoot through the moon back to normal
Again we see the system figured a way out. Why? Why does this ‘system’ keep figuring a way out of these extremely crazy environments? In general, it is because the ‘system’ itself is people. It’s your neighbors, friends, coworkers, and yes…also your crazy politicians. And while we all have various viewpoints and disagree on all sorts of things; including the problems that created the issues or the best way to solve the issues…we still have 1 thing in common. We all want tomorrow to somehow be better than today. When staring down extreme situations; this common ground generally finds a solution. It often takes longer than any of us would like but history shows a repetition of this common ground eventually driving some solution to move us and markets forward.
So where are we at the moment? I would argue things seem somewhat normal. Valuations have bounced back to more normal levels from the 2022 declines, the consumer is thus far remaining very strong, markets are grappling with higher rates but fundamental profits are holding up well. Looking through the lens of a little longer term might shed some light on normalcy.
As of 7/27/2023 (Data from Y Charts)
- 3-year return for All Country World Index (ACWI) = 35.03% ( 10.53% annualized)
- 5-year return for ACWI = 47.81% (8.13% annualized)
- 10-year return for ACWI = 130.30% (8.70% annualized)
8.70% annualized returns for an all-equity investor over the past 10 years is a very reasonable number. The fundamentals of profit growth and reasonable multiples support this result. Going forward we think the long run is still favorable for 7-10% equity returns. Nominal economic growth (GDP) of 5% would imply solid companies that maintain market share can grow around 5% without anything exceptional. Add in strong cash flows for buybacks of 2-4% or reasonable return on invested capital and 7-10% profit growth is very possible from these levels. Any significant declines resulting from fear will be met with opportunistic buying and if we see valuations excel past profit fundamentals we will rotate and trim. Could another recession happen soon…yes and in many ways we still expect a second slowdown is likely as the higher rates work through the system. However, timing this likely slowdown is very difficult as markets have shown this year. Becoming fearful and missing out on the gains or rebound this year would be disastrous. We continue to stay on the path and get solid returns in line with your risk levels while waiting for obvious opportunities. If fear shows up again in the form of a recession we will point to the logic above, remain above emotion and again seek more opportunity. For now, we are in neutral, and after the past few years…neutral feels pretty darn good!
Conclusion
Let me conclude with a quote from the Apollo 13 movie. It reflects often what happens in investing and captures well what the past 3 years have felt like as a manager while we navigated so many variables that seemed to be breaking at weird times.
Television Reporter: Is there a specific instance in an airplane emergency when you can recall fear?
Jim Lovell: Uh well, I’ll tell ya, I remember this one time – I’m in a Banshee at night in combat conditions, so there’s no running lights on the carrier. It was the Shrangri-La, and we were in the Sea of Japan and my radar had jammed, and my homing signal was gone… because somebody in Japan was actually using the same frequency. And so it was – it was leading me away from where I was supposed to be. And I’m lookin’ down at a big, black ocean, so I flip on my map light, and then suddenly: zap. Everything shorts out right there in my cockpit. All my instruments are gone. My lights are gone. And I can’t even tell now what my altitude is. I know I’m running out of fuel, so I’m thinking about ditching in the ocean. And I, I look down there, and then in the darkness there’s this uh, there’s this green trail. It’s like a long carpet that’s just laid out right beneath me. And it was the algae, right? It was that phosphorescent stuff that gets churned up in the wake of a big ship. And it was – it was – it was leading me home. You know? If my cockpit lights hadn’t shorted out, there’s no way I’d ever been able to see that. So uh, you, uh, never know… what… what events are to transpire to get you home.
Sometimes we never know exactly what events will transpire to get us home. All we can do is keep flying the plane and know the system will work out. Shutdowns, supply chain mismatch, government spending, massive rate hikes, multiple administrations, war, and inflation have all been thrown at us in the past 4 years and yet here we are folks. Plans are still working, the system still humming, equities still growing, and risk levels are still being met. And just in case you are worried about markets, recessions, politics, and such…take a look at some of the returns we have seen during recession years as a reminder that economic fear does not always mean bad things for markets!
As always THANK YOU! Our success together is an equal part great team, great advisors, and great clients. We feel extremely blessed to get up every day and do exactly what we love doing. If we did not serve such great families, we would not love what we do nearly as much. It remains a tremendous honor to steward your hard-earned assets and continue helping you meet your long-term objectives. Don’t hesitate to reach out if you have any questions or concerns.
Disclosures
(1) Data reported by Y-Charts Data, www.ycharts.com.
Index results such as the Wilshire 5000, S&P 500, Aggregate Bond Index, and All Country World Index do not reflect advisor or management fees and expenses and you cannot typically invest directly into an index. Our reporting using Y Charts for VTSAX, ACWI, and AGG does reflect the ETF securities and could be invested. Evergreen Wealth Management, LLC is a registered investment adviser. The information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.