Russia and Ukraine, stock market volatility… learn how the latest events and market moves impact you. What could be next for the economy? What investment opportunities are available? Are there financial moves to consider making now? Brian Perry, CFP®, CFA® serves as Executive Vice President and Chief Investment Officer at Pure Financial Advisors.
Questions Answered:
Do you think this is the start of a new cold war?
How will sanctions affect the American companies that are pulling out of Russia as far as their stock pricing, .i.e. Apple, Starbucks, McDonalds, etc.
Why has the United Nations been silent on this international crisis? How is it affecting our inflation?
Europe is much more dependent on oil products from Russia than the US. Problems lately between the US and Saudi Arabia and the UAE seem to complicate the energy situation even more?
Might now be a good time for Europe to become less dependent on Russia as an energy source?
How do you think this impacts Chinese Equities especially if they decide to assist Russia during these global sanctions?
Would you advise increasing your Fixed Income bonds exposure by adding Treasury Inflation Protected Securities (TIPS)?
What market sector do you think is best to be in now for retired folks thinking long term? Large cap, mid cap or small cap? Is there a sector you’d recommend avoiding?
Why still own international stocks if the world is so turbulent?
What is the price of oil going to look like in the short, medium and long run?
If stocks will pick up, would an indexed annuity be a safe place to put money now if retiring next year?
Transcript:
Andi: Now. Please welcome him. Here is Brian Perry, CFP®, CFA®. Brian, how are you today?
Andi: I’m doing great. Thanks, Andi. How are you?
Andi: I’m very well. Good to see you.
Brian: You, too. I like that. Now, hundreds, if not thousands. I’m old enough to remember when McDonald’s used to count the number of hamburgers they had sold. Now they gave up and they’re like, hey, we sold a lot of burgers.
Andi: Millions and millions. Yes.
Brian: Lots of presentations at this point. Very excited for this one. Exciting topic. Russia and the market. There’s a lot going on.
Andi: Absolutely. It’s difficult to not pay attention to the news. So I’m hoping that you can help calm things down for us a little bit.
Brian: Yeah, I’m going to do my best. We’ll try to avoid hyperbole, although it’s hard not to get a little bit excited about some of these things. But let’s also make this interactive. I’m sure that some of the people out there have lots of questions. So let’s make it interactive as we go along and we’ll touch on a few different subjects that are currently in the news.
Andi: That’s one of the things I was mentioning. We already have a number of questions that have come in. People are very interested to know what is going to happen next with Russia.
Brian: Oh, good. I have a Crystal ball with me.
Andi: Perfect.
Brian: I’ve got a few slides on Russia. Why don’t we flip through them and we’ll talk a little bit about what’s going on around there?
Andi: Sounds good. I think we already know who you are. So let’s get on to Russia and Ukraine.
Brian: Yeah. Let’s take a look at a map. And it’s been a little while. This is an oldie but a goodie, the Union of Soviet Socialist Republics. I feel like we went a couple of decades without having to trot this one out. But here it is, a map of the old USSR. I grew up in the 70s and 80s when Russia was the enemy and there were movies about Russia and the Soviet Union. And then the wall came down and it collapsed and kind of receded into the background. And even when Putin came to power, there was a relationship there where it seemed like Russia and the US were, if not allies, at least friendly. And I know Putin and George W. Bush had a pretty good relationship. But in the background, you have a guy in Vladimir Putin that has said that the greatest tragedy of the 20th century was the collapse of the USSR. He obviously comes from that mindset, and in that view, that the USSR was a good thing. I don’t share that opinion. Not a fan of communism over here, but the USSR was the major power, along with the US, in a bipolar world for the better part of the second half of the 20th century, and then suddenly went away. And then you had Russia. And then you had the satellite countries, Kazakhstan and Belarus and Ukraine and Uzbekistan and the like, and then you had the United States. And the United States was really the sole power in the world. And over time, there’s been this rivalry growing a little bit with China, where it seems like China is another country that’s competing for global hegemony. And will China or the US dominate the globe throughout the 21st century? And will it be a bipolar world again with the US and China? And in the background, Russia standing over there going, well, wait, what about us? And looking to expand their sphere of influence into their former areas that they used to control in Central Asia and extreme Eastern Europe.
And if we look at the next slide, a little bit more of a close up of Ukraine. And here you can see Moscow up at the top right hand column, and Russia. And Ukraine is in a strategically important area, in addition to having a lot of history with Russia itself, also sandwiched between the Black Sea, which is an important Port area for Russia, both for exports for oil and also for their Navy. And then to the west with Poland and Slovakia and Hungary and Romania, a lot of European countries, and in particular Poland, a large NATO member. And then above Ukraine, you get Belarus, again, part of the former Soviet Union, also at this point, essentially a Russian vassal state with a very pro Russia government and has agreed there in Belarus to allow the Soviets to stage nuclear missiles. So certainly a close ally. And then Moscow and Russia look to Ukraine and say, okay, here’s another country that is part of our historical sphere of influence, and they’re concerned about them moving westward and wanting to join NATO or deepen their ties with the European Union. And that’s certainly the last thing that Putin and Russia want. As I talk about all this stuff, I want to be honest. I’m not a geopolitical expert. I do have a graduate degree in international affairs. So certainly I have some familiarity and knowledge and background, but I don’t want to hold myself out as an expert in the same way that maybe I know a fair amount about markets and economies. Let me pause. It looks like Andi might already have our first question.
Andi: Sean has already asked, “do you think this is the start of the new cold war?”
Brian: That’s a really good question. If you’d asked me that question three months ago, I would say that I did think that there would be a new cold war, but I thought that the cold war that would eventually come about would be between the US and China. And I still think that could be the case. I do think relations between Russia, and not just the United States, but really the Western world have deteriorated to the point where they’re going to be quite difficult to reconcile. Just my opinion. I don’t see too many scenarios where Putin leaves Ukraine and everything goes back to the way it was 6 months ago. I think that in some way, shape or form he’ll need to get some sort of resolution that allows him to salvage some pride and claim victory at home. And I think any of those outcomes are going to leave America in the west unsatisfied and probably leave some sanctions in place. So, yeah, I think that it could be. I think the next cold war or the next world order, and this is just my opinion, is not so much going to be between just Russia and the United States, it’ll be more the Democratic world and the authoritarian states. So if you take Russia and probably China, and also a country like Iran or some of the authoritative countries in the Middle East, you could probably put them on one side of the ledger and then put the US, Western Europe and NATO, Canada, Japan, Australia, places like that, potentially Latin America as the other side of the ledger, with India as a swing vote. And India is certainly more of a democracy. So I could see the world breaking down those lines in the future. And hopefully it’s a cold war and not a hot war, because I think a hot war has a pretty troubling outcome in that scenario.
Andi: Agreed. Again, if you have questions, type them into the chat and we will get to them throughout the presentation. And I will get back to the slides with you now.
Brian: And as we dive in, I will say that what I just put out is not just my opinion. Like I said, I’m just another Bozo on the bus. My graduate school, the former Dean, now works in the private sector and is a commentator for, I think it’s ABC or NBC. But before that, he had a pretty good job title. He was the Supreme Allied Commander of NATO, which is a pretty good business card. And he recently wrote a fiction book that I read called 2034 and in it, he talks about the next world war based on his history running NATO and I think he ran Latin America for the American armed forces and stuff like that. So pretty smart guy. Got a PhD as well. Again, this is fiction, but what wound up happening was actually a nuclear conflict between the United States on one side and then China, Russia, and Iran on the other. So when I say that, as far as seeing the world tip in that direction, that’s just my opinion. And the book that I’m referencing is fiction. But obviously, if there wasn’t some basis of possibility of that coming true then I probably wouldn’t have used that as a fictional book, and that’s somebody with a far deeper background than I have.
If we slide over the next slide, this is just a close up of Russia and Ukraine and whatnot. But you see Crimea there in the middle of the Black Sea in orange, which was annexed by Russia in 2014. So this is not the first Russian incursion into their former vassal states and looking to take a bigger bite now with all of Ukraine and some of the rationales for the invasion have pretty much been decried by the rest of the world. Hey, it’s because of fascists and neo Nazis in the Ukraine, and that Ukraine is planning to use chemical weapons against Russia. So a lot of false flags are being planted by Russia. I know that there’s some concern at this point about some of the rumors being floated out of Russia that Ukraine has biological or chemical weapons. And now Russia has even claimed that the United States has those same weapons staged in Europe, which Biden has categorically denied. I’ve heard some analysts think that that’s a false flag being planted as a justification for Putin eventually to use potentially chemical weapons or biological weapons in Ukraine. He certainly has a history of doing that, having done that in Syria and the like.
Flash forward to “why is this happening?” And there’s a couple of reasons. One is, quite frankly, Putin’s probably a maniac, but the other parts of it are, it’s Russia’s traditional sphere of influence and fear of losing respect on the international stage and wanting to expand out its fear again. The other is just fear of NATO and the European Union and fear of NATO’s eastward movement. So if you look there in blue is NATO, yellow is _on the lines_, and then the right is obviously Russia. Most of the right hand blue countries that are in NATO were not part of NATO prior to 1997. So it was much smaller and gradually expanded closer and closer to Russia and into their traditional sphere of influence. And there’s a lot of fear that Ukraine (or a country like that) has been asked to join NATO multiple times. I don’t think they’re that close to actually joining, but some concern there. And so that’s one of Russia’s justifications for doing this is to keep NATO where it is. The irony is that in doing this, the fear is probably more likely to become reality. And then I don’t know that Ukraine is going to join NATO. Again, just referencing Admiral Stavridis, who’s the former Supreme Allied Commander of NATO, saw an interview with him and he said that he doesn’t think that there’s much chance of Ukraine joining NATO anytime soon. He thinks that would be a really lengthy process, even without what’s going on right now. But he thought that this could speed up a timeline or a possibility that Finland or Sweden would join NATO. So some of the things that Russia fears are more likely to come about because of this invasion. If we step back and talk more about what this might mean for the future and the economy and the markets, if you look historically (and we’ll talk more about this in a bit), incidents like this are a relatively temporary phenomenon, unless they escalate.
And so what would an escalation look like? I think that there’s really three main possibilities in declining order of horror, if you will. The worst case scenario and the all bets are off scenario is some sort of nuclear conflict where Putin and Russia are losing. They decide to go nuclear, and that nuclear war spreads. And obviously, that’s a worst case outcome. At that point, I’m not sure that what’s happening in financial markets really matters, but whatever’s happening in the markets won’t be good. The second conflict enhancement would be if the war spreads and includes NATO. NATO and the various members have repeatedly said that if Russia attacks a NATO member, that they will invoke Article 5, which is that an attack on one NATO member is an attack on all. So Russia steps into Poland and then NATO comes to the rescue. So if the conflict spreads it would be a significant hit to financial markets and economies at that point. If you get the US and NATO involved, there’s about 150,000 NATO troops in Eastern Europe right now. 100,000 of those are Americans. My understanding, and again, not an expert, but my understanding is that if you look at NATO forces from whether it’s spending, whether it’s combat aircraft, warships and the like, are about 5x what Russia has. So I’m not so worried that the US and NATO wouldn’t win a ground conflict or an air conflict there. It’s more what does that look like? How terrible is it? And then if you get armed conflict between Russia and NATO, you’re increasing the odds of some sort of weapons of mass destruction being used. So in addition to the humanitarian consequences, that’s a pretty bad outcome for financial markets. And then the final outcome, which is maybe the most likely that would expand the war, is a cyber attack. And I do think that the odds have gone up of some sort of cyber attack on either Democratic institutions, financial institutions are pretty well protected, but energy infrastructure, gas pumps, utilities, that sort of thing. Again, reading reports, it sounds like Russia does have the ability to essentially turn off the electric grid in Ukraine if they wanted to from a cyber perspective. But they may be hesitant to do that because it reveals what their capabilities actually are to the west. And so they may not want to play that card unless they absolutely have to. But I think that would be the third form of escalation, which would be pretty disruptive to financial markets. Absent one of those three things happening, though, I think that what we’re seeing, as terrible as it is, will eventually dissipate into the background of what’s really going on with the economy, inflation, et cetera, et cetera.
Andi: Steve has asked a question. “How will sanctions affect the American companies that are pulling out of Russia as far as their stock price, for example, Apple, Starbucks, McDonald’s, et cetera?”
Brian: I think you’ve already seen whatever would happen for most companies. Russia is not a huge economy for a pretty significant power. With all due respect to Russia or anybody from there, if you took away their nuclear stockpile and some of their history, I don’t think that we would talk about them in the same way that we’re talking about them right now. Sure, they’re a massive land mass, but the size of their economy is not that significant. Their GDP and consumer spending aren’t that significant. It’s not like pulling out of China, for instance, as far as the economic hit to companies, and most of those companies have already left. So I think the actual impact will vary company by company, but markets are forward looking. So as Apple pulled out of Russia a month ago, whatever impact that would have on their future earnings should already be priced into the stock.
Andi: And then do you have a take on this? Richard said, “why has the United Nations been silent on this international crisis?”
Brian: I don’t want to go down a rabbit hole of talking about the United Nations and its effectiveness because I know people have pretty widely varying opinions. I think one really big reason is that anything really monumental that comes out of the United Nations has to be approved by the Security Council, and there are 5 permanent members with veto power, and one of them is Russia, and they’re not going to vote to sanction themselves. And another one is China, who’s kind of stayed hands off on this. And I don’t know that they would vote either to approve any kind of strong resolution or action against Russia. So the UN, I would have to guess, is probably not the right body to adjudicate this or get too involved at this stage in what’s going on. Again, that’s speculation on my part.
Andi: We have a few other questions, but they’re specific to what’s going on in the market. So I will go ahead and get back into the slides so that we can get on with that.
Brian: Yeah, let’s transition. One of the things that we’re looking at here is that Russia is not that large of an economy. So what’s the real impact? And a lot of the impact is commodities based, where they’re roughly 12% or so of global oil production and 17% or 18% of natural gas. That’s a pretty big hit. And anybody that’s filled up their car recently has probably felt some of the impact here. And so this is really the true impact we’ve seen with nickel prices, wheat prices. Ukraine is a massive wheat producer. A lot of the commodity disruptions are really the longer term impact. And I think this is more of the story of what is sanctioned out of here. And the world will eventually adjust. There have been other countries in the Middle East that have been sanctioned and that couldn’t export oil and stuff. Different sources will be found. Relative to 20 years ago, there’s a lot more known oil reserves, even just in the United States, as well as around the world. Some of them just take time to come online. So I think markets for commodities will eventually adjust.
But certainly this is a pretty big hit and it’s happening at a time, if we flip over to the next slide, of already high inflation. And I’m sure this isn’t news to anybody that’s watching this, but we’ve had inflation running at essentially sub 2% or at least sub 3% for the better part of a couple of decades, and now we’re running closer to 8%. I think that there’s a few reasons for that. One is the disruption from COVID and the pandemic shutdowns and supply chains. And supposedly that’s supposed to go away, that’s what the Fed was telling us for a while. But I think there’s a couple of other things under the hood. And one is just that the pandemic made companies look at their supply chains and say, okay, what’s going on here is that now all of a sudden we can’t get all the component parts for whatever we’re making from abroad because of shutdowns due to COVID. Maybe we want to reevaluate how much we make overseas versus home. And that’s true if you’re an American company, a Swiss company or whatever. If you start in-shoring what used to be out-shored, that raises your cost of production in most cases and probably then raises the price you have to charge the end consumer, which is inflationary. On the second hand, you’ve also got essentially a doubling of the minimum wage in a lot of places. And people in that income bracket tend to spend 100% of their income. So if you double the income of somebody, they’re going to double their spending. That’s inflationary. It also means that the company doing that, in a lot of cases service jobs, now need to raise the price of what they’re selling because their cost of inputs went up for labor. That’s inflationary. And then the third thing is I think the Fed has become less willing to fight inflation. And we’re hearing a little more rhetoric in action now, but if you think about it, for years the Fed had a dual mandate of fostering full employment and price stability. And then recently over the last year or two, they’ve moved towards full employment and then a secondary mandate. So instead of 1(a) and 1(b), it’s now 1 and 2 really. And the second one being price stability. And they’ve even come out and said that they’re willing to tolerate higher inflation than in the past for a period of time. And there’s a lot more transparency at the Fed, and in my view, that’s not necessarily a good thing because I think that puts political pressure on a body that needs to be independent. If you look around the globe, in countries where there’s a lot of political influence on the central banks, they tend to have higher inflation. And so you’ve got a Fed that was significantly behind the curve with a view that some of these inflation pressures were transitory. You get spiking inflation. And then as we look at the next slide, you throw in oil prices, and you see oil has jumped significantly this year, in part because of what’s going on in Russia and Ukraine. We’re at roughly $70 a barrel and jumped to about $125. We’ve stabilized down at around $102 when I made this chart, and then just in the last couple of days, we’re up at like $110, $112. So another spike higher in oil. This is hitting already strapped pocketbooks on consumers. It’s a really tough position to be in. Now if you are a central banker, on the one hand, you’ve got inflation, and I don’t think anybody could argue that it’s not high right now. So you need to raise interest rates, tighten monetary policy to slow the economy and lower inflation. But at the same time, you’ve got consumers that might have to cut their spending because all their money is going to gas and food. You’ve got geopolitical instability. What does that mean for the economy? So you’ve got a pretty difficult situation here if you are a central banker. And what they do will be interesting to watch.
But as we look over the next slide, it’s important to realize that this is not new territory. This is not unexpected. And one of the key takeaways is that markets are forward looking. It’s not so much about what happens, it’s about what happens relative to what expectations were. And this slide is just a composite of a half dozen or 10 different investment banks and their outlook on the Fed funds rate, that’s the main overnight lending rate. The central bank here in the US controls where it will be at the end of the year. It was zero as of February. It went up to a quarter of a percent in March. You can see that anywhere from 5% to 8% interest rate increases are already forecast. So you saw volatility in markets this week because the Fed said, hey, we might move more aggressively than anticipated relative to expectations. But in a vacuum, just because interest rates are going up isn’t going to blow up the financial markets because it’s already expected.
Andi: We’re just speaking about oil prices. And Theresa said “Europe is much more dependent on oil products from Russia than the US. Problems lately between the US and Saudi Arabia and the UAE seem to complicate the energy situation even more.” And then James said, “might now be a good time for Europe to become less dependent on Russia as an energy source?”
Brian: Yeah. So I don’t have a comment on the US and the UAE and Saudi Arabia. But as far as Europe being more dependent, yeah, they’re very heavily dependent, particularly on natural gas imports from Russia. And I’ve seen estimates that the increase in energy prices could knock as much as 3% off of gross domestic product in Europe. And around the world it will have an impact, too, but the most significant one will be in Europe. So definitely something to watch because of that. Europe has been saying for years they want to be less reliant on Russia for energy, and they’ve taken some steps in that direction, but it’s been halting. And now they’re getting more serious about it with what’s going on. And you saw Germany. There’s two things happening. One is that they are making moves to become less energy dependent on Russia. The other is that they’re increasing military spending. If you think of Russia, you want Europe buying your energy and you don’t want them with a big military. This invasion of Ukraine has almost prompted both of those things to happen exactly the opposite of what Russia would actually want.
So let’s flip forward one, because it’s important to remember that interest rate cycles are nothing new. If you look back to 1990, there have been many different interest rate cycles. I believe it’s 11 different regimes of either interest rates going up or interest rates going down. And this is actually the 6th tightening cycle where rates are going up that the Fed has embarked on since 1994. So this is nothing new. It’s not like this has never happened. It doesn’t happen every year. But the last rate increase was July of 2019. So what’s the impact going to be? Well, all else being equal, it’s going to slow the economy down some. That’s the idea. Or at least cut inflation. But then what about financial markets? And one of the main concerns is the bond market.
Let’s take a little bit of a look at the bond market. And as a reminder, when interest rates go up, bond prices fall. There’s an inverse relationship there. When interest rates fall, bond prices go up. Again, an inverse relationship. There’s a lot of lines on this slide. I probably need to clean it up. But if you just focus on two things, the blue line is the 10 year treasury. And so you can see the high was back in the early 80s at about 15%. Now we’re at about 2.25% or so on the 10 year treasury. The other two lines are inflation, the red and the green. It’s just two different ways of measuring inflation. Focus on the green line. You can see right now we’re at about 6%. The last time inflation was at these levels, the 10 year treasury was at 14%, 15%. Now we’re at 2%. So something has to give. There’s a disconnect. Either A, inflation is going to come down significantly, or B, the bond market is really wrong on its outlook for inflation, because as it is right now, people buying 10 year treasuries aren’t in a great position. So the next logical question is, well, why don’t I just not own bonds? Why don’t I get out of bonds? Bonds stink, right? Here’s the thing. If you look at the last four interest rate cycles, when rates have gone up, bond prices have had positive returns in each of those cycles. I said interest rates go up, bonds fall. But the reality is once the Fed begins tightening monetary policy, that’s usually a positive for bonds across time. Why is that? Well, there’s two reasons. The first is, think about it like this: anybody that’s ever had a job, never went into work, got a raise and walked away disappointed. If interest rates go higher, you get a raise from your bonds. There’s two components of your bond return. One is income. The other is price movement up and down. The price movement is going to take care of itself over time. What you really care about is that income. If rates go up, you get a pay rate. So all else being equal, if your time horizon is long enough, rising interest rates are your friend, not your enemy as a bondholder. Provided, you own relatively short or intermediate term bonds, because those will turn over more quickly. That additional income will come in sooner. The second thing is that all else being equal, if the Fed raises interest rates, inflation is going to be lower. Everything else stays the same. If the Fed does nothing, inflation is here. If the Fed raises interest rates, inflation is going to be something lower than it would be if they didn’t. So interest rate increases from the Fed are actually a positive for bondholders because it reduces future inflation while at the same time getting them more income. And you see the proof in the pudding here. And again, this is no guarantee. But historically, bonds have done okay during Fed rate cycles. You need to give it time. It doesn’t mean they’re going to do great in a month or a week or a year or whatever. But over the cycle, they’ve done okay. Again, focusing on reasonably short and intermediate term bonds. The key is to make sure that the average maturity of your bond portfolio is less than your time horizon as an investor. And you should be okay with rising rates.
So what about stocks? Well, a couple of things going on here. One is market shocks. And so you can see I just picked a few here. The first Gulf War, SARS, the second Gulf War, Russia and Crimea. I mentioned that before. COVID 19. You can look at the S&P 500 performance 3 months, a year, and 2 years after each of those. And what I would point out is that within 12 months, in almost every one of those instances, markets were up, and within 3 years they were up in every one of those instances. So the markets have certainly seen a wide variety of shocks over time and have generally performed okay if we’re looking at stocks.
And if we look at the next slide, this gives another view of it where you can look at this line. This is sad because this is just wars. And this goes back to the 1930s. I haven’t counted the bubbles on here, but there’s a lot. Everything from the Greek Civil War to the Spanish Civil War to World War II to Vietnam to the Falklands to Russia and Ukraine, more recently, Afghanistan. Across that time, you can see that markets have generally moved higher. And that just gets back to the fact that over time, corporate profits tend to increase. Stocks have an upward momentum behind them. Again, absent some sort of major escalation of what’s going on, this will disrupt markets in the short term. Longer term, they’re going to look back more at fundamentals, which always reminds me of what I think is one of the most important quotes I’ve ever heard as an investor. Ben Graham, who is really the father of valuing companies and value investing and was Warren Buffett’s teacher, once said that in the short term, markets are a voting machine, but in the long term, they’re a weighing machine. And what that means is that in the short term, what moves markets are emotion, fear and greed, how people feel about things. But as you stretch out your time horizon, what matters is fundamentals. Our company is making money. Is the economy growing? Is there a properly diversified portfolio? Do you own shares of future prosperity? And historically, if you step back and you say, okay, is life better? Despite this chart, with all these wars and all the other stuff that’s gone on, is life better today than it was in the 1930s? I think most people would say that for the majority of civilization, the answer is yes. There’s better health care, longer lives, people are healthier, better technology, better travel, et cetera, et cetera. And for most of those improvements, some companies made a good or service that improves people’s lives. You can facetime with your kids or grandkids because you have an iPhone. You can travel to see a different country because of United Airlines or whatever it is. You can eat food that doesn’t spoil because of preservatives. So there’s all these different improvements that have made people’s lives better, and those companies are generating profits that flow through to shareholders. So if you think the world is going to continue to get better, obviously in fits and starts, you want to be an investor, because over time, that tide will lift financial markets.
The other thing to keep in mind, though, is buckle up for volatility. As of right now, the S&P is only down about 6% on the year. We were down about 15% at one point on the S&P. The Nasdaq a couple of times was down 20% plus, depending on the day. So we’ve definitely had a volatile start to the year. Bonds are down, too. Stocks and bonds go up and down. The reason you get a return is because you’re taking some risk. The red dots here are intra year declines. The Gray bars are where the S&P ended each year. And what you’ll notice is that about 3 quarters of the time the S&P ends the year up. But what you also notice is that in almost every one of those years, at some point the S&P was down. My two takeaways from that is that, one, there’s going to continue to be volatility in financial markets. And two is that just because you get off to a rough start in the year, it doesn’t guarantee a bad year. The other thing I want to say is consider what the last few years have held. If I sat back there a couple of years ago and I said, all right, in the next two years, we’re going to have the biggest pandemic in a century. The global economy is going to shut down and you can’t leave your house. We’re going to have the largest ground war in Europe since World War II. We’re going to have arguably the most contentious election in a century in the United States. We’re going to have a riot in the capital where people are going to storm the United States capital and try to take it over. I’m sure that I’m missing some things. Oh, and by the way, we’re also going to have the highest inflation in 40 years since Jimmy Carter. If I told you all those things, be honest with yourselves, raise your hands if you would have said, all right, sign me up, I want to buy stock? Ask yourself that. Would you have bought stocks if I told you that’s what the next two years were going to look like?
And if we go to the next slide, let’s look at the chart for the last couple of years. The top is 5 years and then the bottom is 1979. And you can see at the bottom the long term upward trend. And then look at the last couple of years since all those things that I mentioned happened. Stocks are up 90% from the lows and about 40% from the pre-COVID peak. So it’s been a really good period, despite all the messiness that I just mentioned. It gets back to the power of capitalism and the power of being an investor and letting that tide lift your boat higher. So what’s next? Let me pause. Andi, do you have any other questions?
Andi: Yeah, we do have a few questions. Let’s take those now before we get into what is next in 2022. Again, if you do have questions, type them into the chat and we will get to them right now. George says, “Brian, how do you think this impacts Chinese equities, especially if they decide to assist Russia during these global sanctions?” And he has the second question, which I’ll ask after.
Brian: Yeah, a couple of things. One is I think it’s always important. We talk so much about stock markets, but it’s really a market of stocks. So different companies are going to do well or poorly, and then their stock prices are going to reflect that. It all bubbles up to an index at some point. So anything China or any other country does on the global stage is going to impact different companies differently. I think Russia’s invasion of the Ukraine is a rare example of something that’s almost universally bad for almost every company in the country, but that’s pretty unique. First of all, I don’t think China is going to help Russia. This is just my opinion. I think that they’ve looked at the world’s reaction to Russia and they’ve said, wait a minute, do we really want to get involved in this? China is way more interconnected with the global economy than Russia. They have a lot more to lose. You also have their President, who is up for a 3rd term, which would put him in the same company as _Mao and Dang_. He’d be the only other person in that pantheon. And I think they want a lot of stability leading into that. I think their summit is in the fall. So I don’t see them doing something that’s going to cause them to become international pariahs and start getting excluded from the global financial system in the next 9 months. That’s just my opinion. If they did start assisting Russia, I think it would be a negative for equities, but I don’t think it will happen for the same reasons with their upcoming summit and elections, as well as looking at the world’s reaction to Russia and Ukraine. I think an invasion of China into Taiwan is probably less likely now than it was a few months ago. And I’ve heard some people say, oh, is China going to use this opportunity to invade Taiwan? And I would say the answer is no. Not to say that that will never happen or that Taiwan will never be consumed by mainland China, but I don’t see that happening in the near term. If you ask me, I’d be broadly optimistic on Chinese stocks. They’ve had a pretty tough run due to government crackdowns and stuff, and that was probably overdone. The Chinese authorities were probably overzealous. And again, I think they have an interest in promoting stability and prosperity over the next year. And I think you’ll see less heavy handedness from the government and probably a decent return from Chinese stocks.
Brian: And we got an answer to the question you just asked earlier. I believe it’s Ailes said “yes, you buy stocks when there is fear. I would totally buy stocks during bad times and did.” Further on with George’s second question was, “would you advise increasing your fixed income exposure by adding Tips?” And then he said that he meant shifting from Treasuries to Tips.
Brian: Maybe. Tips, for those that don’t know, are an acronym for Treasury Inflation Protected Securities. And so they’re government bonds backed by the US Treasury, the US government that adjusts their value based on where the consumer price index is for inflation. You could. I don’t think Tips are a bad investment and we own them in some client portfolios. The problem is, again, that markets are forward looking. So if you’re going to buy them, you need to think that inflation will either go higher or at least stay at current levels. My view is that inflation actually will be higher than it has been for the past 20 years and perhaps higher than most people expect. But I don’t think it’s going to stay at 7.5%. I think it’ll settle in the 3% to 5% range or something like that. Tips are fine, but you need not just to feel like there’s inflation, but actually to have the CPI ratings coming in high for them to work well. They also have relatively long duration, and duration is a measure of how sensitive a bond is to interest rate movements. Tips, for a variety of reasons, have longer duration than non inflation linked bonds, and so you have a fair amount of interest rate sensitivity. So I think Tips are fine as a component of a fixed income portfolio, but I wouldn’t want them to be the basis of my entire portfolio.
Andi: And then again, if you have questions, now is the time to get them in, because we are going to be wrapping up shortly. Beatrice says, “what market sector do you think it is best to be in now for retired folks thinking long term. Large, small or mid cap? And is there a sector that you would recommend avoiding?”
Brian: Great question. A couple of things. One is I mentioned how bonds have done historically when interest rates and the Fed is tightening interest rates. Similar numbers. If you look at what stocks have done during Fed tightening cycles, they’ve actually been positive in the last handful of tightening cycles as well. And just because the Fed is raising interest rates doesn’t mean stocks are going to collapse. So I would still be reasonably optimistic on stocks, although again, I still think there’s going to be volatility attached. I think emerging market stocks and international stocks are probably cheaper than US stocks and will do okay. Obviously, some issues in Europe just because of the nature of the current volatility being centered in Europe with the war. But if that settles down and shakes out without a major escalation, I think European and global stocks could do pretty well. As a retiree, and again, I don’t know the particulars of the questioner’s situation, but just because you’re retired doesn’t mean you don’t have a 20 or 30 year time horizon for some of your dollars. You might have money you need next year, but money you need in 3 decades. In the long run, small companies and value companies do better. The information and the data is overwhelming that if you put $100 to work back in 1929 when the data became available, if you put that in the S&P today, your $100 would turn into $600,000, which is a really phenomenal return. But $100 put in small companies would be $2.7 million. So about 4 times as much. $100 put in small value companies would be about almost $8 million. So about 13 times more. So over time, small and value companies do the best. So I would certainly want to have some weighting towards that. A lot of people that we see are almost entirely concentrated in large growth companies. Those are some of the companies I’d be slightly more cautious with. I would still certainly want to own them. I wouldn’t want to avoid them. And they might even be the largest portion of your holdings. But I think relative to the indexes, where 20%, 25% of the S&P 500 is in a handful of stocks, I don’t know if I would want to have that kind of weighting in any 5 stocks, particularly 5 large technology companies that have done really well over time that are pretty expensive. I’d probably want to be a little bit more diversified. As far as which sectors, again, if you just look at the data with the Feds tightening interest rates, pretty much all sectors have done okay. Different sectors, depending on the cycle, do better, but there’s no consistency as far as which one does better, at which time. What I wouldn’t want to do, and I’ll end with this for this question, is I wouldn’t get sucked into just what’s done best lately. So in other words, just because commodity companies have done really well with the run up in commodity prices, I wouldn’t just pile into commodities. I’d want to continue to diversify. And that goes for every sector.
Andi: All right, let’s get back into the slides.
Brian: Cool. So maybe we’ll end up with a couple of other slides and then we’ll wrap. Just a couple of things to throw on your horizon. One is that I talked about Fed rate increases. So this is a schedule of upcoming Federal Reserve meetings, May 3rd and 4th. The big story out this week is both the Fed chairman as well as one of the regional bank presidents, Bullard from St. Louis, have come out and really laid the groundwork for potentially moving 50 basis points higher in May. Historically, interest rate increases are 25 basis points most commonly. But there’s been some talk about more at a meeting, potentially 50, because the Fed is viewed as being extremely far behind the curve here on tightening policy. And now you’re seeing some of the Fed officials come out and say, hey, 50 could be on the table. So we’ll see if they move 50 basis points instead of 25 in May. Regardless, unless something really escalates with Russia or the economy suffers some sort of serious hiccup in the next six weeks, I think an interest rate increase in May is close to 100% likelihood.
Later on in the year, if we look at the next slide, silly season is coming up again. So we have another election for those that have missed it. The last one was so much fun and so peaceful and no disagreements among any of the candidates. You never argued with your neighbor over who was right and who was wrong from a political party standpoint. So we can look forward to the peace and harmony of an election season here in a couple of months.
Andi: I like your sarcasm.
Brian: You sense that, huh?
Andi: Oh yeah.
Brian: It’s funny because we haven’t really heard much about the election yet. And I think part of it is just the news headlines are so dominated by Russia and inflation that maybe the elections run a little bit under the radar. But the House and the Senate will be turning over again in November. And I have no opinion. I don’t want to say, hey, Republican, Democrat, better or worse. I just want to throw out there that if you look at this chart, the blue was times that the House and Senate were Democrat, the red, they were Republican. And then the stripes, the leadership was split and markets have more or less gone up during all of those. So just because Republicans or Democrats are in office or whoever seems to be trending stronger, no guaranteed markets are going to fall apart or anything like that. So keep that in mind as we approach silly season.
And then finally, and I’ll end with this, is tax changes. So these are the current tax brackets. These are more or less the lowest in history. Prior to 2017, with the Tax Cut and Jobs Act, that 10% was still 10%, but the 12% was 15%, 22% was 25%,24% was 28%, 32% was 33% and 37% was 39.6%. One of the things with Biden coming into office and the Democrats coming into power was a lot of talk about higher taxes. For a variety of reasons, none of that passed last year. I don’t know if those desires to raise taxes have gone away or not. And so it’s falling under the radar a little bit again with inflation and everything else going on. But don’t be surprised if as the election ramps up into summer and fall and then certainly depending on how the election shakes out, if conversations and talk about higher taxes again come to the forefront. So as you’re looking at your investments, also consider that you want to make sure that you’re positioning yourself efficiently for not just taxes today but taxes higher in the future. We’re scheduled to have higher taxes after 2025. That Tax Cut and Jobs Act I mentioned sunsets after that, so tax rates will go higher. But certainly prior to that, if depending on what happens with the elections, taxes could go higher. And at some point, I think that it’s pretty clear the direction of taxes needs to be higher in order to pay for the national deficit and everything else going on in the country. It seems likely that the long term trend for taxes is higher. So you want to make sure you’re positioning that appropriately. I’ll probably end there, unless there are other questions. But again, just to reiterate, I think that with all that’s going on with Russia, Ukraine, inflation, to keep in mind a couple of things is that the upward trend of markets or the long term trend has been higher, despite wars, despite inflation, despite Fed cycles. Unless we get a serious escalation of what’s going on with Russia, I don’t think it’s going to be a long term disruptive thing to markets. I think it’s more of a short term thing. Again, that’s an important caveat that if it expands, then all bets are off. But at this point, it seems like it’s contained to Russia and Ukraine. And I think I’ll end with that.
Andi: If you do have more questions, now is the time to put them into the chat. In the meantime, I’m going to put up an offer right now. That’s now in the chat and it’s also on the screen underneath the chat because none of us can control geopolitical events or market volatility, but armed with the right information, like the stuff that you’ve been getting today, you can control what happens in your portfolio. You can control your plan for your investments and your retirement. Sign up for a free financial assessment with one of the experienced financial professionals at Pure Financial Advisors and take a deep dive into your entire financial picture. Learn how to protect yourself against market volatility, inflation, rising healthcare costs. Find out how to choose the Social Security Claiming Strategy and Retirement Distribution plan that are right for you, as well as how to legally reduce your taxes now and in the future as things change, as Brian has talked about. And also how to minimize your risk and to maximize your return. This no cost, no obligation financial assessment is specifically tailored for your current situation, your tolerance for risk, and your needs and goals for retirement. So it’s very important that you get the information specific to your needs. Pure Financial Advisers is a fee-only financial planning firm. We don’t sell any investment products, and we don’t earn any commissions. And Pure Financial is also a fiduciary, meaning that we are required by law to act in the best interests of our clients. Schedule your appointment now before the calendar fills up. I’m going to put up a slide right here that’s got all of our contact information on it. Just click the link in the chat and choose the best day and time that works for you. It’s an online video meeting via Zoom, so it doesn’t matter where you are in the country. You don’t have to come into one of our local offices and you can sit down one on one with somebody to get a tailored plan for your needs. Click the link and schedule your free assessment now.
All right, so we did have one other question from Diana. She said, “why still own international stocks if the world is so turbulent?”
Brian: I think for one thing, the world has always been turbulent. This is sad to say, but if you look, the last 20 years have actually been the least bloody in the 20th century. So there have been less wars, less people killed, and stuff like that. They get a lot more headlines and a lot more attention because of the Internet, Facebook, 24 hour news cycle, et cetera. But the world is actually, sad to say, more peaceful today than it has been at any time in the past. And that hasn’t prevented international stocks from doing well at times in the past. You also get different economic cycles because different countries are growing or detracting at different speeds. You get different inflation readings in different countries, and then you also just get different companies. So if you only invest in the US, you don’t buy Nestle or Toyota or other companies that might be really great companies. The other part is just remember, markets are forward looking. So although there’s a war in Russia right now, if it gets worse, markets are going to suffer. But markets already know there’s a war. If it dies down, they’re going to move on to the next thing. And so markets are forward looking. The final part is that valuations are just more appealing. Stocks in a lot of international markets, relatively speaking, are less expensive than in the US. And all else being equal, if you pay less for a security, the return will be better. Not saying you should own entirely and only international securities, but we think a globally diversified portfolio invested in both the United States as well as abroad is probably the best approach.
Andi: Another question came in from, I hope I’m pronouncing this right, Ailes, “what is the price of oil going to look like in the short, medium and long run?” Asking you to prognosticate a little bit?
Brian: Oh, Jeez, man, I don’t know. I’ll give you in the long term. So we’re at $110 a barrel now. I don’t think it stays up there in the long term simply because I think Shell Oil in the United States is, and I’m not an energy expert, but I think Shell Oil is pretty transformational where it can be produced and economical at prices below $100 a barrel, whether at $70, $80, $90, $50, whatever it is. And there’s so much of that, and it can be turned on relatively quickly that if oil prices stay up here, I think other people are going to have an incentive to ramp up production domestically as well as in other fields around the world. And I think there’s enough supply available to bring prices down a little bit. In the short term, honestly, I don’t know. I think a wild card for the economy is if this is the time that you get some sort of unease in the Middle East that brings some of the production there offline, and then all of a sudden you’d have a major issue as far as a price spike to $200 a barrel or something. But again, I don’t have an opinion for 6 months out. But longer term, my guess is we would settle somewhere south of $100 a barrel.
Andi: And Tina says, “if stocks will pick up, would an indexed annuity be a safe place to put money now if retiring next year?”
Brian: Maybe. As a firm, we’re not huge fans of indexed annuities. I think what’s really important is that you look under the hood at what you’re buying. Many annuities have very, very high commissions cooked into them that may not be explained to you and may not be obvious unless you really dive under the hood. They also often have very long lock ups where you can’t get out if you don’t like it. And then finally, a lot of times the performance isn’t as promised. And so what we find more often than not is that people that buy indexed annuities are pretty disappointed in them and could accomplish similar outcomes by building a diversified portfolio of more liquid instruments. But again, it’s case by case.
Andi: All right, I think that is all the questions that we have.
Brian: If you want more details on the one you’re considering, if you come in for one of those free assessments, whoever you meet with can take a look under the hood at the product you’re considering and see the pros and cons of it.
Andi: If you do have more questions and don’t have a chance to get them in now, you can always contact us at the information that is on screen or you can come in for that free financial assessment and get your questions answered one on one, in person, directly tailored to your financial situation. Click the link, schedule that no cost, no obligation, free financial assessment and find out what makes the most sense for your retirement plan for your future. Brian, thank you so much for untangling everything that’s going on in the world right now for us. We really appreciate the time.
Brian: Yeah, my pleasure. Best of luck to everybody out there. It’s a difficult environment to navigate, but navigate it you can. I look forward to seeing some of you in the future.
Andi: All right, everybody have a great day.
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