We live in tumultuous times—memories of an extraordinary financial crisis are still with us while we experience a once-in-a-century pandemic.
Governments around the world are printing money at fabulous rates, including the United States.
These circumstances cause us to ask, what causes inflation?
In the simplest terms:
Inflation is caused when too few goods are being chased by too much money.
Understanding this, the chart below clearly shows why we are experiencing higher inflation than we have in decades, it depicts the Money Supply in the United States over the last 20 years.
Do you notice anything about the money supply recently?
We should be surprised if we didn't have inflation after seeing this chart and understanding what it means.
-Paul R. Rossi, CFA
Market corrections happen about once every 19 months – and we’re at 19. After the stock market’s fantastic growth in 2021, some believe a pullback (or even a correction) may actually be healthy for the markets. Such a pullback is not horribly painful, by historical standards, and smart investors can cushion such a fall.
Why is a market pullback or correction beneficial?
You can think of a mild pullback or correction as a type of blow-off value; it allows pressure to be released to help avoid a much larger breakdown, and it can help prevent a large bubble from forming.
Bubbles occur when stock prices get clearly out of line with the earnings potential of the underlying companies. We saw the consequence of that in the awful Technology crash of 2000-02 and Financial Crisis of 2008-09, when the markets collapsed, and some people lost half their wealth or more. Many companies didn’t survive.
Certainly, market corrections never feel healthy when they occur. People get fearful as the market declines, the media fan the flames by giving investors reason after reason to be afraid. It very well may be, but most modest pullbacks are not the beginning of the next crash.
Since 1950, the S&P 500 has experienced an intra-year peak-to-trough pullback of 5% or more in 67 out of 70 years. So roughly 93% of the time, a 5% correction has taken place from 1950- 2021. This could be considered normal market activity. The good news is many investors admit that a 5% pullback is manageably unpleasant, concerns expand when the market decline hits 10% or more.
When is the Next Correction Coming?
Here is what investors need to remember: the S&P 500 has nearly doubled in value since the market turmoil in March 2020. What has not happened since that time, however, is a selloff of at least 10% - that’s the definition of a market correction. In 29 of the past 50 years or 58% of the time the S&P 500 has experienced a 10% correction. Again, being that this happens more than 50% of the time, so this too should be considered normal. Since 1928, market corrections happen about once every 19 months.
How to Prepare for a Correction
Are you thinking: “I don’t think I can stomach a loss of 10%? Then that’s where the wisdom of diversification becomes apparent. Remember that the data above represent the historical performance of the S&P 500. A well-designed financial plan and portfolio can help ensure you have the proper asset allocation: a proper mix of Stocks (Small, Medium, Large, International, etc.), Bonds (Gov, Corp, Preferred, etc.), possibly some alternative investments, and Cash. Your portfolio should be designed to represent your tolerance for risk.
So having proper diversification can keep you in the “manageably unpleasant” range. If not, you may need to reevaluate your risk tolerance to ensure you are not exposing your nest egg to a larger loss than you can endure. Although the recent market pullback will produce lots of fear, we’ve been here before. If you know what you own and why, then you should rest easy.
-Paul R. Rossi, CFA
The CFA Institute through its research foundation recently published a 130+ page brief with insights from 25 years of Vertin Award recipients.
These luminaries in the investment field come from a range of backgrounds, from Nobel Prize winners, distinguished professors, billionaire hedge fund managers, editors of prestigious academic journals, and authors of some of the most popular investment books ever published.
Although their backgrounds vary widely, they have one thing in common: they have all made significant lifetime contributions in the field of finance.
What is the Vertin Award?
"The Vertin Award is given to intellectual leaders in the investment industry whose ideas are not only compelling in theory but meaningful in practice. The award winners are indeed exemplars of the CFA Institute mission to set the highest standards of ethics, education, and professional excellence for the ultimate benefit of society. It is fitting that this award is named for Jim Vertin, a dedicated volunteer and professional who recognized the potential to create a multiplier effect on the industry by connecting researchers with practitioners." - CFA Institute
"None of us is as smart as all of us,” read the anonymous quote on the wall of James Vertin’s office.
With that quote in mind, we can learn a lot from the collective wisdom of these Vertin winners. Below are a few of the recipient's and their notable comments.
Noble Prize winner
Professor Emeritus Stanford University
CIO, TIAA and author of several seminal books and articles.
Andrew W. Lo
Clifford S. Asness
President, AQR Management
Campbell R. Harvey
Professor Duke University
President, Ensign Peak Advisors
Professor Cambridge & London Business School
Kenneth R. French
Professor Dartmouth College
Cofounder Efficient Frontier Advisors
William N. Goetzmann
Professor Yale School of Management
In reading the insights from all 25 luminaries, several commonalities are found among them:
-Paul R. Rossi, CFA
Download the entire Investment Luminaries and Their Insights below.