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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

The 20 Most Common Investment Mistakes, in One Chart

Here are the top investment mistakes to avoid, from emotionally driven investing to paying too much in fees.

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The 20 Most Common Investment Mistakes

No one is immune to errors, including the best investors in the world.

Fortunately, investment mistakes can provide valuable lessons over time, providing investors an opportunity to gain insights on investing—and build more resilient portfolios.

This graphic shows the top 20 mistakes to watch out for, according to the CFA Institute.

20 Investment Mistakes to Avoid

From emotionally driven investment decisions to paying too much on fees, here are some mistakes that investors commonly make:

Top 20 MistakesDescription
1. Expecting Too Much
Having reasonable return expectations helps investors keep a long-term view without reacting emotionally.

2. No Investment Goals
Often investors focus on short-term returns or the latest investment craze instead of their long-term investment goals.

3. Not DiversifyingDiversifying prevents a single stock from drastically impacting the value of your portfolio.

4. Focusing on the Short TermIt’s easy to focus on the short term, but this can make investors second-guess their original strategy and make careless decisions.

5. Buying High and Selling LowInvestor behavior during market swings often hinders overall performance.

6. Trading Too MuchOne study shows that the most active traders underperformed the U.S. stock market by 6.5% on average annually.
Source: The Journal of Finance

7. Paying Too Much in FeesFees can meaningfully impact your overall investment performance, especially over the long run.

8. Focusing Too Much on TaxesWhile tax-loss harvesting can boost returns, making a decision solely based on its tax consequences may not always be merited.

9. Not Reviewing Investments RegularlyReview your portfolio quarterly or annually to make sure you’re staying on track or if your portfolio is in need of rebalancing.

10. Misunderstanding RiskToo much risk can take you out of your comfort zone, but too little risk may result in lower returns that do not reach your financial goals. Recognize the right balance for your personal situation.

11. Not Knowing Your PerformanceOften, investors don’t actually know the performance of their investments. Review your returns to track if you are meeting your investment goals factoring in fees and inflation.

12. Reacting to the MediaNegative news in the short-term can trigger fear, but remember to focus on the long run.

13. Forgetting About InflationHistorically, inflation has averaged 4% annually.

Value of $100 at 4% Annual Inflation
After 1 Year: $96
After 20 Years: $44

14. Trying to Time the MarketMarket timing is extremely hard. Staying in the market can generate much higher returns versus trying to time
the market perfectly.

15. Not Doing Due DiligenceCheck the credentials of your advisor through sites like BrokerCheck, which shows their employment history and complaints.

16. Working With the Wrong AdvisorTaking the time to find the right advisor is worth it. Vet your advisor carefully to ensure your goals are aligned.

17. Investing With EmotionsAlthough it can be challenging, remember to stay rational during market fluctuations.

18. Chasing YieldHigh-yielding investments often carry the highest risk. Carefully assess your risk profile before investing in these types of assets.

19. Neglecting to StartConsider two people investing $200 monthly assuming a 7% annual rate of return until the age of 65. If one person started at age 25, their end portfolio would be $520K, but if the other started at 35 it would total about $245K.

20. Not Controlling What You CanWhile no one can predict the market, investors can control small contributions over time, which can have powerful outcomes.

For instance, not properly diversifying can expose you to higher risk. Holding one concentrated position can drastically impact the value of your portfolio when prices fluctuate.

In fact, one study shows that the optimal diversification for a large-cap portfolio is holding 15 stocks. In this way, it helps capture the highest possible return relative to risk. When it came to a small-cap portfolio, the number of stocks rose to 26 for optimal risk reduction.

It’s worth noting that one size does not fit all, and seeking financial advice can help you find the right balance based on your financial goals.

Another common mistake is trading too much. Since each trade can rake up fees, this can impact your overall portfolio performance. A separate study showed that the most active traders saw the worst returns, underperforming the U.S. stock market by 6.5% on average annually.

Finally, it’s important to carefully monitor your investments regularly as market conditions change, factoring in fees and inflation. This will let you know if your investments are on track, or if you need to adjust based on changing personal circumstances or other factors.

Controlling What You Can

To help avoid these mistakes, investors can remember to stay rational and focus on their long-term goals. Building a solid portfolio often involves assessing the following factors:

  • Financial goals
  • Current income
  • Spending habits
  • Market environment
  • Expected returns

With these factors in mind, investors can avoid focusing on short-term market swings, and control what they can. Making small investments over the long run can have powerful effects, with the potential to accumulate significant wealth simply by investing consistently over time.

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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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View the high resolution version of this infographic. Buy the poster.

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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