Should I Invest in Stocks?
Investors, and prospective investors, are scanning news headlines, reviewing their monthly statements, and digesting data — most of them full of gloom — and coming away asking “should I invest in stocks now?” or, even more fundamentally, “should I invest in stocks?” These questions are valid, and caution is warranted. In the short run, the stock market can decline by 50% or more. If you own stocks, you need to be prepared for significant price declines.
However, caution shouldn’t lead to inaction and wholesale abandonment of risk. We believe investors should ask themselves “which stocks?” Asking this question can help reduce the risk of a capital loss and increase the likelihood of attractive investment returns. While danger lurks in some areas, there’s strong opportunity in others. Investing has always been a difficult puzzle, but it is a solvable one.
Importantly, because inflation has accelerated during the past couple of years, investors should understand how inflation generally affects the stock market — as well as particular strategies that tend to outperform in an inflationary environment. The ability to maintain a broad perspective, while appreciating the granular details, will likely separate successful investment portfolios from risky or poor-performing investment portfolios.
How has Inflation Impacted the Stock Market?
To understand the current investment environment, it’s necessary to understand inflation and its impact on the stock market. Essentially, inflation leads to a decline in purchasing power and increasing prices. Profit margins generally shrink during inflationary environments due to cost pressures. At the core level, inflation’s impact is generally negative and typically leads to a broad decline in stock prices. However, inflation does not affect all stocks in the same way. Some perform better than others during inflationary periods.
Food and energy stocks have performed well during the current inflationary period — and historically. Businesses with strong brands and pricing power are also more resilient when inflation accelerates. Conversely, companies that are unable to increase prices generally tend to underperform. As their costs rise, their profit margins shrink. Growth-oriented tech stocks tend to perform poorly during inflationary periods because the present value of profits that will be generated far into the future declines when inflation is high.
Tech stocks benefited greatly from rising valuations due to low interest rates. With interest rates increasing, bonds look relatively more attractive and tech stock valuations are coming back down.
What is the Short- and Long-Term Outlook for Tech Stocks
Tech stocks expectations should be tempered at best. Valuations remain at lofty valuation levels, making tech stocks generally unattractive at this time. Over the immediate and long term, we believe rising interest rates and rising prices are likely to hurt the performance of tech stocks. Investors may experience significant volatility — especially to the downside, and especially with companies that are still unprofitable.
Exercise Caution with Tech Stocks
For the reasons mentioned above, investors may want to be cautious about investing in tech stocks. For those who are currently overweight with exposure to tech stocks, we believe it’s worth sitting down with a financial advisor to revisit this investment strategy. The Nasdaq declined by 78% after the dot-com bust in 2000, and many investors lost everything. Any glowingly positive tech stock predictions should be met with a critical eye at the moment and with the lessons of history in mind.
Given that the U.S. stock market forecast and performance have been strong over the past 10 years — the S&P boasts a historic long-term average of approximately 11.8% — it is understandable investors are keenly interested in staying heavily invested in U.S. stocks. In our view, however, investors should tread lightly.
The tailwinds that propelled strong performance are declining and are being replaced by headwinds, in our view. Rising inflation, rising interest rates, and technology stocks deflating from being in an investment bubble pose a potentially significant threat to performance. Furthermore, the dollar has been incredibly strong; when this reverses, U.S. stocks are likely to underperform. The S&P 500 Index experienced a flat decade at the turn of the 21st century, and we may be in a similar environment today.
What is the Short- and Long-Term U.S. Stock Market Outlook?
Since IT stocks constitute a large portion of the S&P 500 Index, the outlook for the U.S. stock market is largely dependent on the outlook for tech stocks and the dollar, which you can review in the above section. In our view, U.S. stock indices are positioned for a decade of weak performance although certain individual stocks should perform quite well. We think the next decade will be a good time to be a stock picker rather than an owner of passive indices.
Assess Your Portfolio’s Geographic Diversification While Considering U.S. Stocks
The U.S. stock market has done well over the past decade, due to the growth of the U.S. technology sector in addition to the strength of the dollar and (formerly) low-interest rates. However, investors should be selective with their exposures in U.S. stocks and focus on industries that tend to weather inflationary environments relatively well such as energy, healthcare, and utilities.
We believe investors with a 100% U.S. stock allocation are probably putting all of their eggs in the wrong basket and should visit with their financial advisor to discuss strategies that give more geographic diversification to reduce risk and enhance returns.
Foreign-Developed Market Stocks
Much like the experience among tech and U.S. stocks, it depends heavily on the market as to which foreign stocks will perform well. Understanding the nuances of foreign markets and specific geopolitical risks will help guide better investment decisions and likely yield better results.
What is the Short- and Long-Term Foreign-Developed Market Stock Outlook?
Investors should watch for a fair bit of volatility in the short term. Europe is grappling with a serious energy crisis that is weighing heavily on its economy. This energy squeeze is forcing many businesses to reduce or eliminate their operations.
Over the long term, there is likely to be broad variance among foreign-developed stocks. Some countries will fare much better than others. For example, resource-rich countries like Canada, Australia, and Norway should do well relative to countries that must import energy and food, such as the United Kingdom. Other markets, such as Japan, are positioned well to provide manufactured exports to the West.
Understanding Macroeconomic Trends as You Invest in Foreign Markets
Investors should look at country fundamentals such as currency values, current account balances, and demographic trends. For example, Canada and Mexico each have unique advantages that should help their economies thrive during the coming decade. For Canada, it’s their natural resource base. For Mexico, it’s their low labor costs and proximity to the United States.
Emerging Market Stocks
We believe the short term is likely to be pretty rocky for emerging market stocks, as we are in the midst of a global dollar liquidity crisis that is hurting emerging market currencies and economies. However, we believe the longer-term outlook is promising for emerging market stocks, especially those from commodity-rich countries such as Brazil, Indonesia, Mexico, and South Africa. Emerging market stocks are poised to outperform in an environment when the dollar eventually weakens.
Consult with a financial advisor who understands the macroeconomic trends in foreign markets and can help interpret those signals into an actionable investment strategy. We strongly encourage you to have a guide when investing in foreign markets.
What is the Short- and Long-Term Emerging Markets Stock Outlook?
As we enter the end of 2022, the global economy is in the midst of a global dollar liquidity crisis that is hurting several emerging market currencies and economies, especially those who have borrowed in U.S. dollars rather than their own currencies. That said, the long-term outlook is good for emerging market stocks, especially those from commodity-rich countries such as Brazil, Indonesia, Mexico, and South Africa.
Keep Your Eyes on Commodity-Rich Countries and Value Stocks
China is a special case due to its size and its deteriorating relationship with the United States. Policymakers in the West may make it increasingly difficult for China to engage in trade with the Western world, creating additional challenges for U.S. investors. We believe that China should be avoided because of the policy risk associated with investing there.
Aside from China, we believe the emerging market outlook has strong growth prospects and reasonable valuations. Working with an advisor who understands how to value emerging market opportunities and identify areas to avoid — either for poor fundamentals or geopolitical risk — can benefit investors immensely.
Commodities may offer one of the few safe havens in the coming decade. Commodities represent a hard asset, and hard assets tend to outperform when inflation is high. However, understanding which materials and services are most in demand, and how they’re flowing through supply chains, is key to knowing which opportunities are most profitable.
What is the Short- and Long-Term Outlook for Commodities and Commodity Producers?
Commodities could do very well due to supply shortfalls or suffer because of falling demand during a recession — only time will tell. In our view, commodities and commodity producers will likely be an advantageous place to invest over the next five to 10 years. There has been a huge lack of investment in commodity production — especially energy — over the past decade, and as a result, supply has become far outstripped by demand. This will take years to bring back into balance, leading to high commodity prices and outperformance by commodity producers.
Investors Can be Cautiously Optimistic about Commodity Stocks
Investors who have a small (or no) commodity-related exposure should sit down with their financial advisors to revisit and discuss the best places to fund opportunities. In the 1970s, the commodity market exploded in price and there is reason to believe it could happen again if inflation stays persistently high.
In our view, value stocks are an attractive investment choice. Many of the companies that fall under the “value” umbrella are “old economy” stocks such as commodity producers, financials, and industrials. Like Warren Buffet, we invest in value stocks by trying to find high-quality companies that are priced at significant discounts to our own estimates of intrinsic value.
Value Stocks May Perform Well (and Likely Better than Growth Stocks)
We believe that value stocks should perform reasonably well, and will likely outperform growth-oriented tech stocks over the next decade. When interest rates rise, Price-to-Earning (P/E) ratios compress and value stocks tend to outperform growth stocks. This is because the P/E ratios of value stocks are already fairly compressed to begin with. For this reason, you do not want to have a portfolio full of growth stocks if inflation stays persistently high. A growth-oriented strategy didn’t work well in the 1970s or in the early 2000s, and we don’t think it will work in the 2020s if inflation remains high.
Currently, the stock market should be approached with caution. The global economy is in a major shift away from globalization to deglobalization and from low inflation to high inflation. A global recession appears to be looming in 2023. China, Russia, and the West appear to be moving apart and this could have significant investment implications for commodity prices, supply chains, and currency exchange rates in the coming years. Additionally, energy and commodity shortages are likely to become more common after years of underinvestment in production capacity.
All these factors are likely to create a “stagflationary” environment that will take skill to approach correctly and patience to see through for investors. The era of buying a few passive index funds and forgetting them for a decade is over. This challenging and puzzling environment is solvable, but the current environment requires nimble thinking and a willingness to maintain a disciplined, guided investment approach.
This article is prepared by Pekin Hardy Strauss, Inc. (“Pekin Hardy,” dba Pekin Hardy Strauss Wealth Management) for informational purposes only and is not intended as an offer or solicitation for business. The information and data in this article does not constitute legal, tax, accounting, investment, or other professional advice. The views expressed are those of the author(s) as of the date of publication of this article and are subject to change at any time due to changes in market or economic conditions. Pekin Hardy cannot assure that the strategies discussed herein will outperform any other investment strategy in the future. The S&P 500 Index includes a representative sample of 500 hundred companies in leading industries of the U.S. economy, focusing on the large-cap segment of the market.