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A Visual Guide to Navigating Down Markets

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This infographic is available as a poster.

Down Markets

Down Markets

This infographic is available as a poster.

A Visual Guide to Navigating Down Markets

Today, markets are facing headwinds due to the impact of capital misallocation to overpriced securities over the last decade. High inflation and rising interest rates have highlighted this misallocation.

Amid market uncertainty, the above infographic from New York Life Investments provides investors with insights to prepare for down markets and shifting economic conditions.

Market Valuations in Context

To start, let’s look at market valuations.

Roughly a year before the market began to turn, the price-to-earnings (P/E) ratio of the S&P 500 Index reached 38 in late 2020—nearly double its 10-year average of 20.3. The P/E ratio is a common valuation measure for equities. This metric shows investors how much they would pay for $1 of earnings.

This suggests that stocks were pricier than long-term averages, hitting steep valuations unhinged from their underlying fundamentals. Ultra-low interest rates likely bolstered valuations, encouraging investors to invest their money in equities versus cash or government bonds, which were at historic lows.

 202020212022*
U.S. Interest Rate Change-250 bps0 bps225 bps
Average Annual CPI Percent Change1.2%4.7%8.6%

*Data as of Q1 2022

As interest rates increased and inflation rose higher, the P/E ratio of the S&P 500 Index fell to 20.8 in April 2022, closer to its longer-term average.

With this in mind, let’s look at the underlying fundamentals and key sectors that may position investors for strength amid a changing macroeconomic environment.

1. Focus on Fundamentals

When interest rates are rising and inflation is high, fundamentals relating to cash flow become more important:

  • Earnings Growth
  • Dividends
  • Return on Invested Capital (ROIC)
    • ROIC is a profitability measure that shows how much a company earns on its invested capital, such as debt and equity.

      Historically, improving fundamentals have been a leading indicator of sector performance over the intermediate-term. Along with this, S&P 500 Index dividends have surpassed inflation over the last two decades. In fact, between 2000 and 2021, dividends paid out increased from $140 billion to $512 billion, or about 3.7 times.

      Not only that, dividends have historically been far less volatile than stocks. Since 1957, stock prices have been more than two times as volatile as their dividend cash flows.

      2. Trouble Can Become Opportunity

      Consumer sentiment is hovering near historical lows.

      The good news is this may be a silver lining for the consumer discretionary sector, which has historically outperformed when sentiment sinks to this level.

      Consumer discretionary stocks cover non-essential items such as restaurants, hotels, and automobiles.

      Consumer Sentiment Index LevelHistorical Odds of Consumer Discretionary
      Outperformance (12-Month)
      < 55100%
      < 6574%
      < 7576%
      > 9550%

      Given historical patterns, the consumer discretionary sector may be poised to accelerate over the next 12 months.

      3. Value in Favor

      Given high inflation and interest rates on the rise, it may present an opportunity for a value investment approach.

      Value stocks are considered underpriced compared to the broader market and are often inflation-sensitive. In the last year, value stocks have outperformed growth by over 20 percentage points.

      On a sector-level, materials, financials, and communication services are valued below their average P/E ratio, along with the following sectors:

      S&P 500 SectorForward 12-Month
      P/E Ratio
      5-Year AverageYear-to-Date Earnings Growth
      Materials13.517.414.6%
      Financials12.113.3-13.7%
      Communication Services15.117.7-5.1%
      Industrials17.519.332.1%
      Real Estate19.019.113.6%

      Source: FactSet, 08/05/22

      Although the tech sector has seen declines in 2022, the sector’s P/E ratio (22.5) is above its 5-year average (21.7) with 9.8% earnings growth year-to-date.

      Market Scenarios

      With the S&P 500 Index experiencing its worst first half since 1970, let’s look at the different scenarios going forward into 2023.

      The below table shows the worst case, base case, and best case scenarios for S&P 500 Index price returns during bear markets, based on data from 1953 to 2020.

      Market ScenarioS&P 500 Index Cumulative Price Return
      During a Recession
      Year
      Worst Case< -18%2001
      Base Case16%Average
      Best Case> 44%2020

      Historical data shows that on average, the S&P 500 Index has returned 16% one year after the start of a recession.

      The following key factors will likely influence market developments:

      • Inflation
      • Consumer Spending
      • Unemployment Levels
      • Interest Rates
      • Corporate Earnings Growth

      So far, the S&P 500 Index has recovered 7% from its June lows as of early September. A similar trend is seen in the NASDAQ Composite Index—an index significantly weighted in tech stocks— which has recovered 8% over roughly the same time frame.

      Keeping a Clear Focus During Down Markets

      As investors navigate down markets, rebalancing to suit their risk profile can be an important part of the process.

      It is also important to remember that markets are cyclical. For this reason, staying invested, diversified, and disciplined are critical for keeping long-term strategic goals in mind.

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Infographics

Visual Guide: The Three Types of Economic Indicators

From GDP to interest rates, this infographic shows key economic indicators for navigating the massive U.S. economy.

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A Visual Guide to Economic Indicators

Economic indicators provide insight on the state of financial markets.

Each type of indicator offers data and economic measurements, helping us better understand their relationship to the business cycle. As investors navigate the market environment, it’s important to differentiate between the three main types of indicators:

  • Leading
  • Coincident
  • Lagging

The above infographic from New York Life Investments shows a road map of indicators and what they can tell us about the economy.

What’s Ahead: Leading Indicators

Leading indicators present economic data that point to the future direction of the economy like a sign up ahead. Here are three examples.

1. Consumer Confidence Index

This key measure indicates consumer spending and saving plans. When the index is above 100, consumers may spend more over the next year. In December, the index jumped to 108 up from 101 in November. This was in part due to lower inflation expectations and improving job prospects.

In the December survey, 48% indicated that the job market remained strong, highlighting the strength of employment opportunities and likely influencing sentiment towards spending in the future.

2. ISM Purchasing Managers Index

The ISM Purchasing Managers Index indicates expectations of new orders, costs, employment, and U.S. economic activity in the manufacturing sector. The following table shows how the index is broken down based on select measures:

IndexNov 2022
Oct 2022Percentage
Point Change
Direction
Trend (Months)
Manufacturing PMI49.050.2-1.2Contracting1
New Orders47.249.2-2.0Contracting3
Employment48.450.0-1.6Contracting1
Prices43.046.6-3.6Decreasing2
Imports46.650.8-4.2Contracting1
Manufacturing SectorContracting1

For instance, in November the index fell into its first month of contraction since May 2020. Falling new orders signal that demand has weakened while contracting employment figures indicate lower output across the sector.

3. S&P 500 Index

The S&P 500 Index indicates the economy’s direction since forward-looking performance is factored into prices. In this way, the S&P 500 Index can represent investor confidence as the index often serves as a proxy for U.S. equity markets. In 2022, returns for the index are roughly -20% year-to-date.

Current Conditions: Coincident Indicators

Coincident indicators reflect the current state of the economy, showing whether it is in a state of growth or contraction.

1. GDP

GDP indicates overall economic performance. Typically it serves as the most comprehensive gauge of the economy since it tracks output across all sectors. In the third quarter of 2022, real U.S. GDP increased 2.9% on an annual basis. That compares to 2.7% for the same period in 2021.

2. Personal Income

Rising incomes indicate a healthier economy and falling incomes signal slower growth. Personal income grew at record levels in 2021 to 7.4% annually amid a rapid economic expansion.

This year, U.S. personal income has grown at a slower pace, at 2.7% on an annual basis as of the third quarter.

3. Industrial Production Index

Strongly correlated to GDP, the industrial production index indicates manufacturing, utilities, and mining output. Below, we show trends in industrial production and how they correspond with GDP and personal income indicators.

DateU.S. GDPPersonal
Income
Industrial
Production
2022*7.3%2.7%4.7%
202110.7%7.4%4.9%
2020-1.5%6.7%-7.0%
20194.1%5.1%-0.7%
20185.4%5.0%3.2%
20174.2%4.6%1.4%
20162.7%2.6%-2.0%
20153.7%4.7%-1.4%
20144.2%5.5%3.0%
20133.6%1.3%2.0%
20124.2%5.1%3.0%
20113.7%5.9%3.2%
20103.9%4.3%5.5%
2009-2.0%-3.2%-11.4%
20082.0%3.8%-3.5%
20074.8%5.6%2.5%
20066.0%7.5%2.3%
20056.7%5.6%3.3%

*As of Q3 2022.

As the above table shows, factory production collapsed following the 2008 financial crisis, a key indicator for the depth of an economic downturn. Meanwhile, personal income sank over -3% while GDP fell -2%.

Despite economic uncertainty in 2022, industrial production remains positive, at a 4.7% growth rate, albeit somewhat slower than 2021 levels.

Rearview Mirror: Lagging Indicators

Like checking your back mirror, lagging indicators take place after a key economic event, often confirming what has taken place in the economy. Here are three key examples.

1. Interest Rates

Often, interest rates respond to changes in inflation. When rates rise it can slow economic growth and discourage borrowing. Rising interest rates typically signal a strong economy and are used to tame inflation. On the other hand, low interest rates promote economic growth.

Following years of record-low interest rates, the Federal Funds rate increased at the fastest rate in decades over 2022, jumping from 0.25% in March to 4.25% in December as inflation accelerated.

2. Consumer Price Index

This inflation measure can indicate cash flow for households. Inflation is often the result of rising input costs and increasing money supply across the economy.

Sometimes, inflation can reach a peak after an expansion has ended as rising demand in an economy has pushed up prices. In November, U.S. inflation reached 7.1% annually amid supply chain disruptions and price pressures across food prices, medical prices, and housing costs.

YearInflation Rate Annual Change
2022*7.1%2.4%
20214.7%3.5%
20201.2%-0.6%
20191.8%-0.6%
20182.4%0.3%
20172.1%0.9%
20161.3%1.1%
20150.1%-1.5%
20141.6%0.2%
20131.5%-0.6%
20122.1%-1.1%
20113.2%1.5%
20101.6%2.0%
2009-0.4%-4.2%
20083.8%1.0%
20072.9%-0.4%
20063.2%-0.2%
20053.4%0.7%

*As of November 2022.

3. Unemployment Rate

The unemployment rate has many spillover effects, impacting consumer spending and in turn retail sales and GDP. Historically, unemployment falls slowly after an economic recovery which is why it’s considered a lagging indicator. When the unemployment rate rises it confirms lagging economic performance.

Overall, 2022 has been characterized by a strong job market, with unemployment levels below historical averages, at 3.7% as of October.

On the Road

To get a more comprehensive picture of the economy, combining a number of indicators is more effective than isolating a few variables. With these tools, investors can gain more perspective on the cyclical nature of the business cycle while keeping a long-term perspective in mind on the road ahead.

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Europe’s Energy Crisis and the Global Economy

Europe’s energy crisis could last well into 2023. Here’s how the energy shock is causing ripple effects across the broader economy.

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Europe’s Energy Crisis and the Global Economy

Volatile energy prices are squeezing household costs and business productivity in Europe.

While energy prices have fallen in recent months, several factors could influence price volatility looking ahead:

  • Russia slashing energy supplies
  • Rising winter heating demand
  • Shrinking European storage facilities

In the above infographic from New York Life Investments, we show the potential impacts of Europe’s energy crisis on consumers, businesses, and the wider global economy.

1. Impact on Consumers

Energy plays a central role in overall inflation. Here’s how it factors into the consumption baskets of various countries:

CountryEnergy %
of Inflation
Total Inflation Rate
(Sep 2022)
EnergyFoodAll Items Less Food
and Energy
Germany46%9.9%4.5%1.8%3.6%
Italy42%8.7%3.7%2.2%2.8%
Japan42%3.0%1.3%1.0%0.8%
France29%5.6%1.6%1.6%2.4%
United Kingdom28%8.8%2.5%1.3%5.0%
U.S.17%8.2%1.4%1.0%5.8%
Canada15%6.8%1.0%1.3%4.5%

Source: OECD (Oct 2022). Annual inflation is measured by the Consumer Price Index.

As the above table shows, energy makes up nearly half of consumer price inflation in Germany. In the U.S., it contributes to about one-fifth of overall inflation.

Amid energy supply disruptions, U.S. winter heating costs are projected to rise to the highest level in a decade. As heating costs rise, it could impact consumer spending on discretionary items across the economy, along with other essential household bills.

2. Impact on Business

Natural gas and petroleum are key components in many industries’ energy consumption. As a result, the recent rise in energy prices is adding significant cost pressures to operations.

Below, we show how four primary sectors use energy, by source:

U.S. SectorPetroleumNatural GasRenewablesCoalElectricity
Transportation90%4%5%0%<1%
Industrial34%40%9%4%13%
Residential8%42%7%0%43%
Commerical10%37%3%<1%50%

Source: EIA (Apr 2022). Figures represent end-use sector energy consumption in 2021.

In Europe, soaring energy prices have led to production declines in energy-sensitive industries over recent months. As a ripple effect, European fertilizer production capacity has decreased as much as 70%, crude steel capacity has fallen 10%, and aluminum and zinc production capacity has sunk 50%.

In response, some companies may move production out of Europe to regions with lower energy prices. This occurred in 2010-2014 amid high European energy prices, where companies relocated to the U.S., the Middle East, and North Africa.

3. Impact on the Economy

While the energy crisis is having devastating effects on many countries, some markets like the U.S. are more sheltered from the impact. As seen in the table below, the U.S. produces virtually all of its natural gas. Figures are shown in trillion cubic feet.

YearU.S. Natural Gas
Production
U.S. Natural Gas
Consumption
Net Imports
20213531-4
20203331-3
20193431-2
20183130-1
201727270
201627271
201527271
201426271
201324261
201224262
201123242
201021243

Source: EIA (Sep 2022).

By contrast, Europe imports 80% of its natural gas, primarily from Russia, North Africa, and Norway. Not only that, natural gas imports have increased over the last decade, up from 65% of total supplies in 2010.

Meanwhile, the energy sector is seeing strong returns supported by higher oil and natural gas prices, along with key fuel shortages as Russia constricts supplies to Europe. In November the S&P 500 Energy Index was up 65% year-to-date compared to the broader index, with -17% returns.

Europe’s Energy Crisis: Looking Ahead

Given the complex geopolitical environment, Europe’s energy crisis could last well into 2023, driven by many factors:

  • Rising demand from China post-COVID-19 lockdowns
  • Lower European fuel reserves
  • Inadequate energy infrastructure in the medium-term

The good news is that European government relief has reached €674 billion ($690 billion) to cushion the effect on households and businesses.

However, this has additional challenges as increasing money supply may be an inflationary force.

Amid market volatility, investors can avoid getting caught up in short-term market movements and stay focused on their long-term strategic allocation.

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