Should high interest rates and election cycles alter your investment strategy?
When looking at the stock market headlines, there appears to be some disconnect between how consumers are feeling about the economy. After dropping 25% between June and October 2022 when inflation was running hot and the Federal Reserve was rapidly increasing interest rates to bring price pressures down, the S & P 500 Index has continued to climb to new highs. While many economic fundamentals have remained strong despite the Fed’s efforts to cool the economy – job growth has remained strong and unemployment low with more workers coming back into the labor force, consumers are having a challenging time adjusting to higher prices, keeping consumer sentiment well below average.
Some of the disconnect between stock market returns and perceptions about the economy may be due to the fact that the S & P Index’s rise has been driven by a handful of technology stocks, namely Apple, Amazon, Google, Meta (Facebook), Microsoft, Nvidia, and Tesla. After leading the interest-rate driven market downturn in 2022, these companies quickly regained the favor of investors accounting for more than 60% of the index’s return in 2023 and for the first half of 2024. Consequently, investors holding stock portfolios diversified beyond large US companies or more heavily weighted in dividend paying stocks are likely experiencing fear of missing out since the returns of their stock holdings have not kept pace with the “Magnificent Seven.” This emotional response can trigger a couple of investing mistakes that can hurt long-term returns. First, investors can be enticed to chase returns, loading up on stocks that have the best performance and holding them too long. Others may see the headline index numbers reaching new highs and fear that stocks are overvalued leading them to keep savings in cash rather than stomaching the potential volatility of stock prices.
Cash is certainly a more attractive holding place with rates on certificates of deposit, Treasury Bills and money market mutual funds topping 5%. However, interesting historical insights from the latest Guide to the Markets from JP Morgan Asset Management suggest that investing in stocks, even at all time highs, can still be a winning long-term strategy. Despite a short-term ratchet effect, stock prices tend to move higher over time. The difference in cumulative total returns for the S & P 500 Index when funds are invested on any given day versus at a new market high was found to be minimal over 3-month and 6-month periods. Over longer periods, funds invested at an all-time high actually earned much more, 79.6% cumulative return over five years against a return of 73.8% for cash invested on any other day. With longer time horizons, it turns out that new highs are rather good entry points.
Investors who get too comfortable with CDs can also miss out on significant positive returns over shorter periods. The Guide to the Markets also provides data on 12-month returns for stocks and bonds after CD rates peak during Fed rate-hiking cycles. Historically, 6-month CDs had an average return of 7% over the following twelve months while bonds posted a 15% return, and stocks averaged a 22% return. Of course, these historical averages may not hold for any specific future period, but their insights may help an investor avoid the trap of moving whole-hog to cash and staying there too long.
Election years can also give investors reason to eschew stocks in favor of cash until after the winner is declared. Elections produce considerable uncertainty for sure, but the stock market is agnostic as to which party’s candidate occupies the White House. Stocks have marched higher under both parties, making investing based upon which party is in office a losing strategy. Despite uncertainty, election years also tend to be good for stocks in the short run. On average, stocks have risen 11.6% on average during presidential election years since 1926. Moreover, the strongest returns tend to occur in the third quarter, just before the November election.
The bottom line is that market timing, whether it be trying to avoid investing at market peaks or based on a political preference, is not likely to be a winning approach over the long run. Rather, investors who stay diversified with an allocation to stocks, bonds, cash, and other asset classes are likely to achieve the best returns while keeping volatility in check.
David T. Mayes is a CERTIFIED FINANCIAL PLANNERTM professional and IRS Enrolled Three Bearings Fiduciary Advisors, Inc., a fee-only advisory firm in Hampton. He can be reached at (603) 926-1775 or[email protected].
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