2023 - The Year That Gives Everyone A Narrative

This has been one of the more fascinating years in economic and market history. The environment is so strange that there’s a narrative for pretty much everyone. For instance:

Permabears can argue:

1. Industrial production has slowed to 0%.
2. PMI has been contracting all year.
3. Retail sales have slowed to 0.5%.
4. Housing starts and mortgage applications are down 40-50%.
5. Inflation-adjusted commercial real estate is down 20%.
6. Inflation-adjusted residential real estate is down 5%.
7. The stock market has been negative for two years and is still down -14% adjusting for inflation.
8. Equal weight S&P 500 is up 8% in 2023. The Dow is up 7%. Both of which are barely on pace to beat T-Bills.
9. REITs and broad real estate market indices are down -25% from the 2022 highs.
10. The regional bank index is still down -16% year to date and -29% from the highs.
11. Core PCE inflation is still 4%+, double the Fed’s target.

Permabulls can argue:

1. Real GDP has averaged 4% for two years.
2. Monthly payroll growth has averaged 422K for two years and 258K in 2023.
3. Nominal residential home prices are barely down.
4. Housing starts and construction bottomed late in 2022.
5. The Nasdaq is up 40%+ this year.
6. The S&P 500 is up 17.75% this year.
7. Homebuilders are up 40% this year.
8. Regional banks are up 35% since the banking panic in May.
9. Headline inflation has fallen from 9% to 3%.

As Oprah might say, “you get a narrative, you get a narrative, you get a narrative!”. There truly is something for everyone in here. And while there’s validity to all of these narratives, I think the one thing we should all agree about is that the last few years have been one heckuva crazy rollercoaster. No matter which market you’ve been involved in, the ride has been hyper volatile and probably hasn’t taken you very far from where you started. After all, even with the S&P 500 up 17.75% this year, it’s still down -5% since the peak in 2022 and has done so with a standard deviation of 20%. That’s a horrific risk adjusted return by any measure.

We try to avoid falling into either one of these camps by targeting specific time horizons. As disciples of the John Bogle school of thought, we try to stay fully invested in the market while also trying to manage our own behavior in a manner that helps us stick to that fully invested position over time. Our All Duration approach is specifically designed to help people match liabilities with specific assets across very specific time horizons, so as to help people get away from this sort of binary thinking. But it isn’t always that easy. Here we are talking about the stock market’s recent performance, and yet it’s a 17-year instrument in our All Duration methodology. So we should be saying “who cares what the stock market does over 17 months when we know it’s a 17-year instrument!”.

Avoiding the narrative biases is largely about compartmentalizing things over the proper time horizons. I can’t tell you how much comfort the All Duration approach gives people when we implement it in tangible terms. After all, time is the core problem that financial planners and investment managers try to solve. The error along the way is that we often take long-term instruments, like the stock market, that are designed to perform a specific way in the long-term, and then we obsess about them in the short-term and try to transform them into short-term instruments that they’re not. Sometimes it works, but in most cases, we’re all just churning up taxes and fees along the way. ¹

Our general view is that these unusual times are likely to continue and that exacerbates all of these temporal and emotional biases that we all encounter as we navigate life. We are still digesting Covid, inflation still remains too high, growth is slowing in many important economic indicators and the Fed is determined to win their battle with inflation. More importantly, we know that environments with low unemployment, high valuations and restrictive credit are consistent with poor risk-adjusted returns in the stock market.² The last 7 months of performance doesn’t change that. And more importantly, all of this creates an environment that is ripe for hyper-emotional narratives, fear/greed and uncertainty. The good news is, you don’t have to take a lot of long duration risk to create certainty in an environment where T-Bills yield 5.5%. And having a good time-based financial plan can help you compartmentalize your assets in a manner that helps you avoid the sort of binary thinking that often leads to catastrophic investing mistakes.

1 - A better example here is a 10-year AAA-rated bond yielding 4%. You can trade that instrument over 10 years until the cows come home, but you cannot make that bond yield more than 4% per year on average. Yes, some traders will earn more/less than 4% as they try to time the price changes, but on average the traders of that instrument will earn 4% before taxes and fees and no more. The same general story is true of the stock market over long periods of time.

2 - It sounds counterintuitive, but the stock market’s largest drawdowns typically occur in environments where unemployment is LOW, credit tightens and valuations are high. This combo is a recipe for bumpy stock returns as seen in the last 24 months.

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Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.