“Good times never seem so good…”
By Chris Lafayette, CFA
“Bull markets climb a wall of worry” is a notion seasoned investors are likely familiar with. If not, they should be after this year. Put simply, the saying means that stocks often go up as investors worry about a known market risk in what feels like an uncertain time. This phenomenon is so pervasive in stock market history that to cement the concept in your mind, I’d suggest belting out a modified version of the lyrics from Neil Diamond’s classic “Sweet Caroline.” Take a deep breath and sing, “good times never seem so good,” like you were well into the night at a good friend’s wedding.
By most accounts, the biggest contributors to the S&P 500’s 18.1% decline in 2022 were the Russia-Ukraine conflict, surging inflation, and the Federal Reserve’s desire to slow the economy by increasing interest rates. All these issues remain unresolved in 2023, yet the S&P 500 index has rebounded 16.9%, as of this writing.
The stock market never flashes an all-clear signal, telling investors that it’s safe to buy stocks at any given time. Rather, in retrospect, it’s often periods of high perceived risk, like March of 2009 when the US financial system was on the brink of collapse, or March of 2020 when the country was experiencing record GDP declines, that would have proven timely buying opportunities. Most of the time, we find the market as a whole is neither extremely over- nor underpriced, but rather certain pockets are doing better than others, and investors are left with mixed signals about what they should be doing.
Periodicals offering investment advice suggest that at various points in time one should be either “in” or “out” of the market to capture or avoid the future movement of stocks. While this type of thinking dominates newspaper headlines and CNBC, very few investment managers have been able to employ a timing approach consistently and successfully over time. The problem is, first, you have to predict an event which in itself has countless variables contributing to an outcome, and second, you have to predict how the market will react should that event indeed occur.
Certainly, some economic news has come in better than expected in 2023: businesses have remained incredibly resilient, inflation, while still high, has slowed, and supply chain stress has eased. But not all data has surprised to the upside: interest rates have moved higher than expected and the Fed seems determined to keep these rates higher for longer. Such rate increases, and the resulting impact on the economy, could portend a recession. Finally, irrespective of all the economic data, stock indices seem most impacted by the unexpected enthusiasm surrounding artificial intelligence this year.
This commentary might make it seem that investing is a completely unpredictable exercise, where sometimes bad news is good news for stocks and outcomes are completely random. However, at Trust Company of Vermont, our approach is not focused on particular events that may or may not determine the market’s trajectory. Instead, we invest with thoughtful analysis, attempting to own companies that will make it through the inevitable difficult economic times, contribute to the innovation that drives America, and maintain strong corporate governance, such that shareholders will participate in the rewards.
Our stock-specific focus doesn’t mean that we ignore macroeconomic indicators. In 2022, we looked closely at how rising interest rates would impact each stock that we own and whether the Russia-Ukraine conflict would slow delivery of products and services in certain sectors. We are aware that just because the stock market is less concerned about a recession this year, doesn’t mean that it is any less of a threat to stock prices than it was last year – if anything, it’s likely the opposite. However, by building diversified portfolios of strong companies, we are able to stay invested in the face of worry, knowing that in the long term this allows us to reap the market’s full rewards.
If we go back to the idea of a friend’s wedding and make an analogy to the stock market, we can imagine that good and bad songs represent good and bad years for stocks. Importantly, at this wedding the band isn’t taking requests, and the songs change abruptly from one to another. If our goal is to maximize enjoyment of the evening, the only way to ensure that we are dancing to all our favorite tunes is to stay on the floor while the duds play. There will be some tough songs to dance to, but it will all be worth it when you find yourself singing “Sweet Caroline” at some point in the night. n