Stock market rally could be the ‘start of the recovery’: Strategist

Wes Crill, Dimensional Fund Advisors Head of Investments Strategists & Vice President, sits down with Yahoo Finance Live to discuss what to take away from today’s market rally, recession indicators, inflation risks, and the relationship between the Fed’s interest rate hikes and the housing market .

Video Transcript

SEANA SMITH: Well, let’s dig into the markets here. For more on that, we want to bring in Wes Crill. He’s Dimensional Fund Advisors head of investments and vice president. Wes, we just heard Jared say, the Dow, S&P, and NASDAQ, all three of the major averages, having the best day that we’ve seen in about three weeks, coming off a pretty rough week for the markets. So help us put today’s gains into perspective.

WES CRILL: Yeah, of course, and thank you for having me on today. You know, I think days like today are a great reminder that investors should have some caution, in terms of reacting when there is a market downturn. Last week, the S&P 500 had crossed into what’s typically defined as bear territory, you know, going beyond a minus 20% decline since the earlier high this year.

You know, what we see from the data historically is that there’s been 15 instances in the past when the US market had a decline meeting that threshold of minus 20%. And in about 2/3 of those, it’s turned around, you know, rather quickly and actually did not even reach the next threshold, which would be minus 30%. And so what we could be looking at today is– you know, maybe this is the start of the recovery, and that’s why it’s so challenging to make these calls on markets.

There’s a little experiment that we often like to point to, which is that if you were to go back to 1990 and put $1,000 into the S&P 500 and say consistently invested, by the end of last year, you would have had right around $20,000 from the initial $1,000 investment. If you had missed the best five days in the market– five days, one week– during the course of over 30 years, your total return would have been about 1/3 less. You would have had about $13,000. And so timing markets very challenging, and it’s days like today that reinforce that lesson.

DAVE BRIGGS: And Wes, we saw from Goldman, doubling their prediction–likelihood of a recession from 15% to 30% over the next 12 months. Are you pumping the brakes on that prediction?

WES CRILL: Yeah, recession is another thing that investors often look to as a potential indicator for what they should be doing in their portfolios. Now, one thing that’s really important to keep in mind is that by the time a recession is called, it’s typically backdated because it’s oftentimes informed by economic indicators that are on a lag. In many recessions, by the time they’re called, they’re close to actually being over. And this is based on a dating methodology that’s done by the National Bureau of Economic Research.

The recession that occurred in 2020 was actually deemed as being over before it was called. The declaration that we were in a recession in 2020 happened in June, and the recession was determined to have ended back in March. So it’s not a great indicator because it’s not happening in real time, in terms of investment decisions. And about 2/3 of the time with recessions, by the time the recession determination is called, the bottom of the market, so the extent of the downturn associated with that recession, is already over and we’re already on a path to recovery . So again, I go back to this notion that in and of itself is not going to be a good indicator of where the market’s going to go. And in fact, historically, the market is going to be in a better place soon after the recession is called.

SEANA SMITH: So Wes, what’s your strategy at this point? Where are you putting money to work, and what looks most attractive to you in this environment?

WES CRILL: Well, we go back to first principles. We want to be consistently invested in accordance with the investment objectives, and we believe investors should be broadly diversified. And our portfolios, regardless of the asset class, we have portfolios that are spread across in different market capitalization levels of equities, different regions– US, developed, ex-US, emerging markets– many fixed-income strategies. And across all of these tens of thousands of stocks and bonds that might be within our portfolios, we believe in one common focus, which is using market prices and staying consistent and using the information in prices continuously. Because like it was mentioned earlier in this broadcast, value has been on a run.

And we believe in a value premium every day. We believe that if you’re pursuing a value premium, it’s important to be there when it’s delivered. That’s been a big part of capturing it historically. So our portfolio has been consistently exposed to these drivers of expected returns. And in that way, we can avoid missing out on these premiums, you know, like we alluded to earlier, with just missing a handful of days of the equity premium.

DAVE BRIGGS: Wes, you talk about pricing. Do you sense that or see any data that suggests inflation has finally peaked or still a ways to go?

WES CRILL: Well, that’s another indicator that, obviously, investors have spent a lot of time looking at. And you know, this is– investors are always looking for some piece of good news, and this is one of the instances where maybe there is a light at the end of the tunnel in terms of inflation. The proxy that we can point to for the investors’ aggregate expectations of inflation is referred to as breakeven inflation. And it represents the difference in yields between an inflation-protected bond of a given maturity and a nominal bond of the same maturity.

So for example, one year out, looking at breakeven inflation is a proxy for the market’s expectations of inflation over the next 12 months. And that’s an interesting indicator to look at over the past couple of months because at the end of March, it was peaking at about 6.2%, implying an expectation of 6.2% inflation over the next year. As of this morning, it was down to under 5%.

So that downward trend in terms of the trajectory of breakeven inflation does suggest the market believes there is going to be a softening of inflation. Now, I always like to throw in a caveat here, which is there’s a difference between realized inflation and expected inflation. And so for example, if we look at the inflation print that came out at the end of April, it was 8.3% over the trailing 12 months– very high. That’s why it was very newsworthy. Now, if you were to go back to the beginning of that 12-month period and look at what the breakeven inflation was then, it was 2.7%. So that tells you that a good chunk of that inflation over that 12-month period was unexpected by the market.

So for investors who are going to be sensitive to uncertainty in realized inflation in the future, there are inflation-protected solutions that they can invest in to mitigate that uncertainty. But that expected inflation we believe is reflected in the prices of different assets, and that’s why we’ve seen, historically, that most asset classes have delivered positive average real returns, even in high-inflation periods. But it is nice to see that the expectation is dwindling a little bit.

SEANA SMITH: Hey, Wes, real quick before we let you go, housing– I want to get your thoughts on that because existing home sales this morning falling for the fourth month in a row. We know Fed Chair Jay Powell was asked about housing, his thoughts on the sector just last week. How is the market or how are you, as an investor, looking at some of the slowing that we’re seeing in the housing market?

WES CRILL: Well, I think sometimes people look at it as another indicator. They’re trying to make an assessment about what the direction is for the economy. We believe that’s one of many inputs that goes into market prices. That’s why we believe that markets are such a great prediction of the future. And in fact, to the extent that changes in housing prices or housing market activity are related to the economy, well, we feel like markets are giving you a better sense for what direction that’s going to go at any rate. In many cases, we see that historically, when there’s been a contraction in the economy, it’s been preceded by a poor year in market returns.

The contemporary relation– so if I look at GDP growth in a given year and then look at the market’s return in that same year, it has very little correlation between those two. And so we believe, to the extent that housing indicators or any other economic indicator is suggesting a direction for the economy, we do believe that it’s already reflected in market prices. So again, the best way investors can weather the storm of whatever ends up being the case with the economy, you can do so through a consistent investment allocation.

DAVE BRIGGS: Good stuff. Wes Crill, appreciate you joining us here.

WES CRILL: yeah.

DAVE BRIGGS: Have a good one.

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