Wesley Chapel, FL

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SPY performance. Month of June highlighted with red vertical lines.
*SOURCE:* *Tradingview.com*

The S&P 500 finished June down 8.64% (using the SPY ETF as a proxy) for the month. That is a little better than where it sat at the lows on June 17th when it was down a little over 12% for the month and down over 23% for the year 2022.

The market (again based on the S&P 500) officially entered a technical bear market on the day I wrote my last commentary, June 13th, and then continued to slide for a few days before recovering a bit.

Two days after publishing my June commentary, the Federal Reserve Bank (The FED) announced it was hiking the overnight lending (or Fed Funds) rate by 0.75% - or 75 basis points. The current Fed Funds rate now stands at a whopping 1.50%.

At least the rate doesn’t start with zero anymore!

Elevate Market Chat recorded July 7th. Click to play or visit, like, and subscribe to our YouTube channel. New videos are recorded and posted every Thursday.

This was the first time since October 1994 that the FED raised rates by 0.75%. But things were much different then… In October 1994 inflation (based on the CPI) was 3.0% and the Fed Funds rate after the hike was 5.25%. In the prior quarter GDP grew by 4.3% and 4th quarter it grew at 4.1%. For the full year 1994 GDP grew by 4%.

Today, CPI is 8.6% and the fed funds rate after a doubling hike is only 1.5%. In case it isn’t obvious, let me point out that the Fed Funds rate was higher than CPI by 2.25% back in 1994. Today, the Fed Funds rate is 7.1% lower than CPI…

On top of that, GDP in the first quarter of 2022 actually declined by 1.6% and according to the Federal Reserve Bank of Atlanta’s GDPNow estimate, it will be negative again for the second quarter. Even though the NBER may not call that an official recession, two consecutive quarters of declining GDP is certainly not representative of a healthy and growing economy.

The FED wants to give the appearance that they are “aggressively” hiking interest rates to combat inflation. But the truth is that they are nowhere near having any sort of impact on inflation with their policy decisions. The only reason that inflation is even remotely beginning to moderate (if it is even moderating) is due to base effects, which I covered in a previous commentary.

We will find out more later this week when CPI for June is reported on Wednesday morning - July 13th. I again expect the it to come in high but probably lower than last month’s 8.6% and not enough lower to stop the Fed from raising interest rates again when they conclude their next meeting on July 27th. An early indication comes from the Manheim Index which showed a 1.3% decline in the price of used vehicles in June from May.

The following day (June 28th) we will get the first estimate of second quarter GDP. I have a feeling the FED will get an early look at that GDP number before the rest of us… for now, the GDPNow estimate is for a drop of 1.2% - the second consecutive quarter of declines.

Fed Funds rate
*SOURCE:* *Tradingview.com*

The PhD economists at the FED have said they think the “neutral rate” for Fed Funds is 2.5%. The neutral rate is the rate that neither stimulates nor restricts economic activity. That means (if you trust their analysis) they would have to take the Fed Funds rate above 2.5% to begin restricting economic activity and having an impact on inflation. And even after June’s “largest hike since 1994” as the headlines read, we are still 1% from the neutral rate. And the odds that the FED will hike by 1% in July are slim to none.

The FED has signaled and the market currently expects that the FED will hike rates again at their July meeting by another 0.50% and then again at their September meeting by 0.50% again. So, under that scenario it will be September before we even get to the neutral rate. Meanwhile, inflation will likely moderate itself due to base effects and somewhere along the line the FED is likely to take credit for that and hit the “pause button” on their rate hikes.

The glaring problem is that hitting the pause button while still only at the neutral rate could easily reaccelerate inflation when the market realizes the FED doesn’t have the resolve to really bring inflation back down to its stated 2% target.

In such a scenario, the market will likely rally along with the prices of food, energy, houses, and everything else.

As I pointed out back in my April commentary:

“The FED has painted itself (and our country) into a corner. Either they tighten (raise rates) monetary policy into a slowing economy (GDP and CPI) which will make a recession worse, probably leading to massive unemployment and social unrest. Or, they act to save the stock market by easing monetary policy (cutting rates or printing money to buy more bonds) and leading to ever higher inflation.
All I can say is this: don’t count on the FED to deliver magical outcomes.”

The FED should have been aggressively hiking interest rates last summer when they were busy calling inflation “transitory.” Instead, they not only didn’t raise the Fed Funds rate, but they actively continued printing money and buying bonds to keep interest rates artificially low which has the effect of goosing inflation.

In fact, just last week Fed Governor Chris Waller responded to a question about what took the FED so long to start raising rates with a rare honest answer. He said:

“Looking back to 2021, I would say that the thing that we didn’t do well in 2021 is we did not pursue the right risk management strategy… We kind of ‘bet the farm’ that inflation was transitory and would come down on its own. But we should have been asking, ‘What if it doesn’t come down? How should be prepare for that contingency?’”

There you have it.

The people we are supposed to trust to guide our economy are failing to manage risk while “betting the farm.” You can’t make it up.

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The spread between the 10-year Treasury rate and the 2-year Treasury rate. The spread is typically a positive number indicating a normal yield curve. Negative spreads between these rates means the 2-year rate is higher than the 10-year rate and generally precede recessions.
*SOURCE:* *St Louis Fed*

And somehow, we are supposed to trust them when they say that they can orchestrate a “soft landing” for the economy now. The soft landing is defined as reducing inflation without causing a recession. I think they only way they can do anything even remotely close to that is if they get their friends over at the NBER to simply not declare a formal recession.

In any event, “soft landing” means about as much to me as “transitory inflation.”

With events like this it isn’t hard to understand why “confidence in major U.S. institutions” among adults in the USA just hit an all-time low according to a Gallup poll that goes back 43 years.

In case it doesn’t jump out at you… The largest decline according to the poll was confidence in the U.S. Presidency.

Meanwhile the White House Press Secretary said last week:

“We are stronger economically than we have been in history.”

Again… you can’t make this stuff up.

I’ve said it before, and I’ll say it again. Our economy cannot afford our government.

In last month’s commentary I wrote about the Forward Price-to-Earnings (Fwd P/E) ratio and how it is used to determine whether businesses (and their stocks) are comparatively cheap or expensive. I concluded that it was likely that the “E” portion of the ratio was going to be coming down as we got into the second half of the year.

Well, just today, I got a note from our friends at Sentimentrader that said:

“Over the past five days, analysts have issued a net of more than 500 price target and earnings downgrades on S&P 500 stocks.”

So, the “E” in the Fwd P/E ratio is already coming down and second quarter earnings season hasn’t even started yet. These analysts are concerned, and they are racing to get ahead of company earnings reports which unofficially start later this week with JP Morgan (JPM) reporting on Thursday, July 14th.

Turning back to interest rates for a moment… Just because the FED seems to be impotent in hiking rates aggressively enough to seriously combat inflation, that doesn’t mean the bond markets aren’t getting decimated.

Sure, the stock market has had a rough start to 2022 – its worst start since 1970. But the 10-year U.S. treasury bond which is probably the most important price in the entire global economy is having its worst year since 1788! That is right around the time the Founding Fathers of our nation were ratifying the U.S. Constitution.

So long as the FED continues failing to get inflation under control you can expect the bonds to continue falling and rates to continue rising.

Of course, rates won’t rise and bonds won’t fall in a straight line, but if history is any indication, a multi-decade bear market in bond prices may have just begun.

You see, bond prices and interest rate cycles tend to last a really long time. The most recent bull market in bond prices coincided with a consistent decline in interest rates from their highs back in the early 1980’s. As the 10-year interest rate fell from 15% or so, to 0.50% in the summer of 2020 bond prices consistently rallied. It was hard to lose money in bonds during that 40-year period.

But prior to that peak in interest rates, they were rising from their previous low achieved all the way back in 1946. So, from 1946 to 1981, 35 years, bond prices fell while interest rates rose.

With that in mind, many of our clients (and those of you reading this commentary) may have seen the end of the last bond bull market of their lives. If the future is anything like history, we could be in for a new 40-year period of rising rates and falling bond prices.

For reference, the stock market rose over both periods, albeit with substantial volatility. Between 1946 and 1981 the stock market dropped by more than 20% five times. One of the drops was 36% and another 48%.

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**Sequence of Returns Illustration**
Both scenarios (one on the left, one on the right) are identical except for the order in which the returns come is reversed. Both are taking 5% of a $1,000,000 portfolio adjusted upward by 3% per year for inflation. The left scenario experiences strong market returns in the early years and the scenario on the right experiences poor returns in the early years. Both have the same (5%) average return over the 20 year period.
**Do you have *any* control over the sequence in which the market delivers returns?**

Those kinds of drops could spell disaster for a retirement portfolio. Selling more stocks to generate the same amount of income in a declining market is financial suicide – particularly if those drops happen early in your retirement. Click and enlarge the sequence of returns illustration nearby.

What is a retiree to do when bonds are essentially uninvestable and the stock market is too volatile?

Well, as I quoted last month:

“If your retirement income plan depends on an accurate prediction of markets, you are doing it wrong.”

There is a better way to secure your lifestyle and retirement income. It takes a little planning and organization, but it is totally worth it. If you are concerned about your retirement income, I encourage you to get in touch with our highly credentialed Retirement Income Experts, Ken or Kyle.

And for those of you who aren’t yet to the stage where it is time to start spending the money you diligently saved for retirement, the best place to be is in a combination of high-quality stocks, a little bit of gold, and a LOT of cash.

Rising interest rates have the effect of increasing the value of the U.S. Dollar while everything else is declining in value – including stocks and bonds. So, dollars are what you want to hold onto until something changes. Eventually, the market will turn and there will be a time to aggressively put money back into stocks.

That time is (still) not now despite what most advisors in the Financial Services Industry will tell you. In fact, as I pointed out last month, the industry’s advisors have largely spent their entire careers convincing anyone who would listen that it is always a good time to buy. And I got some more evidence of that from readers… I can’t hep but share a few items with you.

First, check out this email one of you got from another advisor:

There are all sorts of common things in there that advisors say to get clients to either keep all their money invested in something, or to invest new capital. Nothing in here indicates that the advisor would recommend selling or holding cash. Some of the material is even very misleading. For example, in my May commentary, I wrote:

Many advisors who have a poor track record of trying to time the market (either on their own or for clients) say things like, ‘it’s not about timing the market, it’s about time in the market,’ and other clever things. They will show you a chart outlining how bad your return is if you miss just the 25 best days in the market each year, and use that to get you to keep your nest egg invested for the long-run no matter the economic environment.

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Performance missing the best 25 days ***and*** ***worst*** 25 days.

Well, as you can see in this advisor’s email, he wrote almost exactly what I said. He used the 10 best days instead of 25, but the idea is the same. And he failed to mention that the 25 worst days and the 25 best days often happen very close to each other – and by missing both – you can outperform the market! There is also no mention that those extremely volatile days almost always happen when the market trades below its 200-day moving average, as it (still) does today.

He goes on to talk about all the great opportunities that are out there to “stock up on.” As if it is always a good time to put your money to work!

I am not even really trying to pick on this one advisor either. That is why I blacked out his name and left the firm out of it.

And he is not alone… Just take a look at this article… They (almost) all say the same thing – and it’s (almost) all garbage.

Advisor 1: “If you have time on your side, then invest and it will increase your wealth.”

Advisor 2: “Take advantage of the sale. Twenty years from now it won’t matter the price of today. You’ll just be happy you kept buying.”

Advisor 3: “Clients in the accumulation phase should just keep buying.”

Advisor 4: “Am I recommending clients buy now? Yes… which is best, buying at the market high or when prices drop and represented a bargain?”

Advisor 5: “We do suggest that our clients invest into the market right now — because we suggest they do so regularly, regardless of what markets are doing…”

Advisor 6: “I'm investing cash as clients make deposits. It's business as usual… It's always possible that you're buying in before continued market downside but you're just as likely to miss some of the best days of market returns waiting… Stay the course, stay invested and keep investing additional regularly if you can.”

Advisor 7: “Now is definitely as good a time as any to be buying into the market. In a perfect world, the client has not stashed up excess cash and is consistently investing every month.”

Advisor 8: “Yes, I recommend clients buy now.”

Advisor 9: “I don't know by how much or when we will find a bottom, but I know that this is a rare opportunity to buy at a discount.”

Advisor 10: “For their longer term goals, I tell them that now is a good time to invest, because they likely have enough time to grow their money significantly by purchasing investments at a discount.”

Advisor 11: “We stay the course, stick to the savings/investment rate that supports their short-, mid- and long-term goals, and rebalance portfolios into the target asset allocation as needed.”

Advisor 12: “If they have the ability to increase the amount of money they put in the market, I would encourage that.”

Advisor 13: “Bear markets are unsettling for most investors. But for the brave and the disciplined, they may represent an opportunity to invest more.”

Advisor 14: “Whenever the market is off 20% or more it is certainly a good time to buy into the market…”

Advisor 15: “For younger clients who have decades to retirement it can be an opportunity to invest…”

It absolutely blows me away that out of 15 advisors, not even one expressed any concern about their clients putting their hard-earned money to work in this current market environment. Some are downright reckless with their “certainty.” And others are blatant about it always being a good time to invest. I am convinced if these same advisors were asked the same question on December 31st, 2021, before the market dropped nearly 24% to its lows (so far), they would have essentially said the exact same things.

If you ever needed evidence of how we are different at Elevate, there you have it.

We use cash to diversify our risk. Intentionally. We will have the rest of our lives to buy the next bull market on dips once the environment turns bullish again. There is no need to aggressively invest in the current environment.

It might even turn out that we are wrong and now is (or June 17th was) the low of this bear market. But even still, just because it is/was the bottom, doesn’t mean that it was a good idea to put money to work there. I’ve done all sorts of things in my life that worked out for the best, even though they were ill-advised (to say it kindly.)

The point is to understand how much risk is involved compared to the potential reward before taking a “leap of faith.” Until the market starts to behave normally, until inflation starts to fall, until GDP begins to rise, until the FED starts to back off its hawkish (inclined to raise rates) policies… there is simply no edge in putting money to work aggressively.

And it isn’t that we aren’t buying anything. We added two new stocks to our strategies in June - our first new positions since early April. We started with small 2% allocations in each with the intention that those initial buys would only represent 1/3rd of the ultimate position size. These stocks are both in the Health Care industry and have held up much better than the markets overall this year.

To be clear, we aren’t afraid to put money to work. But we also aren’t just recommending people dollar cost average their hard-earned money into a pie chart of index funds knowing that the market could easily sink another 10%, or 20%, or more, before a real bottom is achieved.

Clients, I encourage you to click here to access your personalized performance portal to see how your portfolio held up vs. last month’s 8.64% drop in the SPY!

Until next time, I thank God for each of you, and I thank each of you for reading this commentary.

Shane Fleury, CFA
Chief Investment Officer
Elevate Capital Advisor

Legal Information and Disclosures
This commentary expresses the views of the author as of the date indicated and such views are subject to change without notice. Elevate Capital Advisors, LLC (“Elevate”) has no duty or obligation to update the information contained herein. This information is being made available for educational purposes only. Certain information contained herein concerning economic trends and performance is based on or derived from information provided by independent third-party sources. Elevate believes that the sources from which such information has been obtained are reliable; however, it cannot guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based. This memorandum, including the information contained herein, may not be copied, reproduced, republished, or posted in whole or in part, in any form without the prior written consent of Elevate. Further, wherever there exists the potential for profit there is also the risk of loss.