by Franklin J. Parker, CFA
- Last week’s unemployment figures were very good, with the headline unemployment rate ticking downward which was unexpected (last month’s revision also reversed the recession signal we saw here last month). Services PMI, however, signaled a contraction for the first time since 2020. The services sector has held the economy afloat for the most part, so a contraction here does not bode well for the economic outlook. Despite the negative news, markets traded higher, almost entirely in response to the market’s new expectation for a 0.25% rate hike from the Fed (as opposed to a 0.50% rate hike).
- This week we see data on consumer credit, consumer sentiment, and the all-important inflation data for December. Inflation is expected to tick downward from 6.0% to 5.7%, and that would likely fuel further expectations of the Fed being less aggressive in its rate hikes. This week also kicks off earnings season with the big banks reporting on Friday. Last quarter saw earnings slow considerably, and investors expect earnings to contract in this quarter (see this week’s chart).
- In my view, investors have mispriced the Fed’s actions at the end of the month, and that may be a serious error. While there are signals the economy is slowing (and I believe a recession is forming), the signals the Fed is watching have not changed much, and I expect a 0.50% rate hike while the market expects a 0.25% hike. If the Fed holds its course, markets are likely to give back much of the gains we’ve seen in the past couple of days. When coupled with a lackluster earnings season and recessionary signals, it is easy to see that caution is warranted here.
Why do we care so much about looking out for, and protecting against, recessions?
Because the order of your returns matters.
Imagine two real-world investors, both with $500,000, both earning a 12.2% average return over 30 years, and both making 6% withdrawals from their portfolio.
Lucky begins his retirement in 1981. By 2010, he has over $5,000,000—10x his original investment! And that is after going through 2008.
Unlucky begins his retirement in 1930 and makes the same 6% withdrawals. His portfolio doesn’t last past year 10, despite investing in a 30 year period that made the same average return as Lucky’s.
The reason is that the order of your returns matters. Having bad first years can destroy your ability to maintain a lifestyle through retirement (or any ongoing goal). Understanding these kinds of risks and working to offset them is a very important aspect of goals-based investing, and something we look at closely.
Chart of the Week
Analysts see a rocky first half of this year, with an expectation for earnings to contract around 2% for last quarter (but reported this quarter), and then staying flat until the back half of this year. My view is that the back half of the year won’t be much better than the front half, and could be considerably worse. We will be watching the data closely.
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