Four Key Questions About Today’s Market

To say the last 12 months have been eventful for investors would be a massive understatement.

Some folks are out there screaming Armageddon.  Others are more sanguine, at least for the time being..

For a variety of reasons (more on this below), I find myself in the latter camp.  That being said, here are some questions I’m asking myself as we are approaching the first anniversary of the bear market.

#1: Is The Housing Situation As Bad As It Seems?

Assume you piled into the housing market at the very peak, buying a $1m house at 80% LTV.

If annualized inflation runs at 5% over the next 5 years, the real value of your mortgage will decline to approximately $620k in five years’ time ($800k x 0.95 ^ 5).

A melting ice cube – but one working in your favor for a change.

Now, I’m not smart enough to figure out what happens to the nominal (or real) value of that $1m house in five years – or where housing prices will take us from here onwards.

Directionally, prices ought to decline versus the peak given the rise in rates and the macro slowdown.

As a result, long-term net buyers of real estate (whether investors or folks who are buying bigger houses as a result of starting a family, etc) should benefit.

That being said, locations with restricted supply could see prices hold up – and I definitely don’t see builders rushing to build more housing in the current environment.

More broadly, buying (and holding) real assets during inflationary periods is far from a bad move – even if you bought at or close to the market peak.  For all we know, things could still turn out better than expected.

Bonus points for those who financed their purchases with long-term, fixed-rate mortgages.

#2:  What Is The Real Market Loss?

The real market loss since the absolute high of 4,818 at the start of this year is about 25%.

But, with inflation running close to 10%, the real loss investors are incurring is 35%.  Still not as bad as some of the previous drawdowns, but we may actually be much closer to the potential bottom than it appears.

Historical Bear Markets

Source: AWealthOfCommonSense.com

The other point to keep in mind here is what inflation does to our future returns.

Even if the market stabilizes at some arbitrary level over the next couple of years, elevated inflation will mean we continue to lose money in real terms.

The bullish argument is that sooner or later, inflation drives earnings.

If the stock market is flat while earnings are rising, that means the valuation multiple is compressing.

Eventually, multiple compression comes to an end, marking the beginning of a new secular bull market.

#3:  Is Cash Still Trash?

One clear difference as compared to last year is that you can now get decent interest rates, possibly upwards of 5%, on the cash sitting in your savings account.

At first glance, that doesn’t sound too bad, though you do have to lock your money away for a couple of years to get that posted rate.

However, with inflation touching high single digits, the real return on your cash is minus 5% (5% nominal return minus 10% inflationary erosion).

Invest $100, get $105 next year – but that $105 will only be worth $95 in today’s dollars.

In some ways, it’s even worse than before (when nominal rates were zero, your annualized real losses would have equaled the inflation rate of about 2-3%).

Should you still have a healthy emergency fund?  Absolutely.

Do you want to increase the size of your emergency fund given we are heading into a recession?  Possibly.

But I wouldn’t let rising nominal returns misguide you into thinking that having a portion of your INVESTABLE assets in cash now is somehow better than it was in the pre-inflation world.

You should also avoid locking up your cash for extended periods of time as that will impact your ability to take advantage of the downturn.

#4:  Are Exchange Rates Masking The Extent Of Your Losses?

If you’re outside the US but heavily exposed to US equities, your portfolio probably looks healthier than it really is.

If that’s the case, a double-take may be in order.

For example, the S&P 500 lost about 17% over the past 12 months:

At the same time, the VUAG (the sterling-denominated Vanguard S&P 500 tracker) is actually UP 3%:

The reason, of course, is the GBP which depreciated exactly 20% in the same time period (I’ll spare you the chart as it’s too painful to look at).

Now, you may have a strong view as to the direction of the GBP over the next 5-10 years.  I certainly do, and it’s not positive.

But it’s an argument that transcends the UK.

The broader point here is that the dollar can’t rise forever, meaning either more pain for foreign investors (if the market continues to decline) or an offset to an upcoming market recovery.

One way to come out of a market crisis stronger and wealthier than ever is to replicate the playbook that worked in previous crises.

Thankfully, that playbook is nothing but straightforward, and goes along the following lines:

Don’t panic – and definitely don’t panic sell.

Waterproof your financial situation.  The last thing you want is to become a forced seller of assets at depressed prices.

Keep investing in productive assets, notwithstanding the price on the screen.

Most importantly, compartmentalize investing.  Yes, it’s important to stay on top of your finances, but not at the price of deprioritizing the other areas of your life.

Downturns may last as long as 3-4 years.  Don’t spend that time glued to the screen.  Get outside, spend time with family, pick up a hobby.

Enjoy life.

Your future (and wealthier) self will thank you for it.

As always, thank you for reading – and happy investing!