In this week’s podcast, Brendan, Tim and Casey discuss the most recent economic headlines including this week’s inflation reading, last week’s jobs report and Q2 earnings.
The guys highlight a theme that’s been apparent over the last couple of weeks… the market’s reactions are more based on expectations rather than what’s actually going on right now.
Managing your investing expectations can play a large part in the long-term outcomes of your financial plan.
Tune on in!
Investing is All About Managing Your Expectations – Full Transcript
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Casey Mullooly: Hello. And welcome back to the Mullooly Asset podcast. This is episode 404. I’m your host Casey Mullooly joined by Tim and Brendan this week. How’s it going guys?
Tim: Good. Happy to be here.
Brendan: Mullooly brothers episode.
Casey Mullooly: Thanks for hopping on. So, we’re just going to run through what we’ve been seeing in the market and the economy at large over the last week or so here. And the big talking point is, the CPI reading for July came out. It was expected to come in at 8.7%. It came in at 8.5%, which was the same as it was in June.
So, there’s been a debate going on of whether or not inflation is 8.5% or 0%. So can you guys explain what it is, actually?
Brendan: This is just a Rorschach test. We’re holding up ink plots and you’re creating your own story based on which one you feel-
Tim: What you see.
Brendan: Yes, exactly. So, like Tim said, both are technically correct-
Casey Mullooly: Year over year, it’s eight and a half percent. Month over month, it’s zero. Those are just from
Brendan: They can coexist. And the message I think, as you’ve led us into was that, inflation is still hot, but maybe it’s not accelerating anymore since a month over month number slowed, which would be a positive sign. Although we have a long way to go.
Tim: I think it’s all relative, if you want to look at it on a monthly basis, it hasn’t moved or it stopped going up at least. But if you want to look at it year over year, it’s still historically pretty high.
Brendan: It’s funny because those are the two time periods that we look over, month over month, year over year. And it’s simpler than maybe looking at… But when we look at things like inflation or even talking about market returns, we look at them over multi-year periods to get a sense of the longer term trends that are in place.
And inflation was picking up through the back half of last year, and certainly now in this year, of course, but if we looked at a two or a three year instead of month over month, year over year, if we expanded that too, you get a totally different inflation rate and maybe that colors your opinion too.
And again, none of them are wrong. They’re just different sets of data. And you can do with them as you please.
Tim: Having just passed the CFP exam. That makes me think of a practice question that I remember from taking a test.
And when you’re using assumptions in your plan of what inflation rate you should use when building out some of the plans, the wrong answer was using this current year’s inflation rate and the explanation underneath it was, you shouldn’t use just one year of inflation as your assumption moving forward, like Brendan said, you should use a longer period of that to get a more stretched out flatter view of inflation over time, as opposed to what is currently inflation right now.
Brendan: It’s tough to deal with because you have to… Tim’s exactly right. You want to use stuff with a good historical basis to make long term plans with, but when you do that, you need to be ready for the variability in the short term results that occurs along the way of getting those averages.
But just taking one year of results and extrapolating into the future, you can’t do that. You do have to live through years like this, where maybe it turns out that over the next 10, 20 years, in fact, if I had to guess, I would say, this will probably be the case.
Over the next 10, 20 years, we’re around what the long term inflation rate has tended to be, here in the United States. And this will just be a period of time that was on the higher end and it’ll be coupled with lower readings that average it out. That’s how these readings work. Market growth goes the same way.
Casey Mullooly: I was just going to say, I think we’ve been having that discussion in terms of market performance, so far here in 2022. I think 2019-
Casey Mullooly: … 2020, 2021, we saw some larger than expected returns from investment performance and people were coming in and being like, “Hey, I know that we can get 10, 12, 15% from the market each year. I am going to bake that into my plan and just assume that moving forward. And like you guys said, I think that that is dangerous.
Brendan: And we’ve gotten similar questions over the last rolling calendar year now, with regard to inflation and retirement projections, financial planning work, along the lines of when do you begin to factor in these higher inflation readings to the plan when we’re talking about variables and assumptions. And I think that that’s a very valid question. At least so far, it hasn’t been prolonged enough that we have updated plans to reflect something more comparable to the rates that we’ve been seeing this year.
You can play around with, what if scenarios. What if we averaged 5%, 6% annual inflation over a retirement period? And of course it’s going to have an impact on the numbers. I’m just not sure about the value of doing that just yet, because it obviously makes plans a lot more difficult, because you need to see corresponding growth that helps you combat that. That’s the whole point. So it’s stuff we’re thinking of.
And so, we talk about long term inflation trends with financial planning that span decades. We get readings that are month over month or year over year, and the numbers are the numbers, but you can have fun with numbers and people are definitely having fun with numbers this week.
Casey Mullooly: So it really boils down to how you measure things, how we talk about moving the goal posts a lot. So, whether it’s month over month or year over year, you can change how you measure things and let the data tell whatever story it may.
But I think one of the themes that we’ve seen, over the last couple of weeks, this week, it’s been inflation. We’re still in the midst of earning season for quarter two. And one of the themes that’s emerged from that has been, I think the market has been maybe positioned for worse earnings reports than expected.
And those haven’t really materialized and the market has responded accordingly here. We’re recording this in August. So, the last four to six weeks here have been pretty good since June. So it’s that expectations versus reality debate that I think really does play out in the market.
Tim: And I think there’s so many different variables that go into what… even before inflation, it was whether or not we’re in a recession. And it’s like, “Well, how do you quantify what equals a recession?” If you want to go by the textbook definition, it’s this. If you want to look under the hood and really scrutinize all the different data points, maybe you come up with a different result and the same thing yesterday.
Technically, if you want to get technical about what constitutes a bull and bear market, the NASDAQ reentered a bull market, because it’s rallied over 20% since the bottom that we last saw in June. It’s kind of nitpicky and it leaves it up to interpretation. And like Brendan said, you can make these numbers, do whatever you want.
Whether you think we’re in a recession, or inflation is 0%, or we’re back in a bull market. A lot of people would argue that, “Let’s pump the brakes before we deem this bear market over.”
Casey Mullooly: I think we’re definitely not here to take a victory lap and we’re not calling bottom or inflation peaked at all.
That’s not what we’re doing here. I think, what we’re doing is pointing to how fleeting investing based on macro headlines, like this, can be and how difficult timing decisions and investing based off of the latest swings and sentiment can be, because we’ve gotten the full spectrum of that this year. And if you were acting based on all of this information, you would’ve drove yourself crazy this year.
Brendan: It’s confusing too, because it’s not even necessarily about whether the specific data point is a good or a bad thing. We always talk about, if you had pieces of information ahead of time, if you knew what the CPI prints from this week were going to look like, or if you knew ahead of time what earnings would’ve been, you don’t necessarily know how to act on them, unless you have an appropriate gauge of what sentiment is.
Because going into it, numbers themselves cannot be good or bad. It’s good or bad relative to what. And so, the thing that everybody talks about is, it’s not good or bad, it’s better or worse than expectations.
And so that’s what we’ve seen this week with the inflation stuff in particular, and with some of the earning stuff too, is that maybe the numbers aren’t… I wouldn’t say that eight and a half percent year over year inflation is a good thing, but the short term month over month result it’s not even going down.
It’s just that it wasn’t accelerating and maybe that was not good, but also not bad enough to continue being bad. So it was okay. And so, the market’s moving up as a result of not being so bad.
Casey Mullooly: I was going to say, I think it’s interesting, this week especially, because of last week’s jobs report, it largely beat a lot of people’s expectations and the market responded accordingly. So this was also the first time this year that the actual inflation reading came in lower than the expectations for it. So, like you said, definitely not good and-
Brendan: It’s getting there. It was positive enough to not be as negative as all the other ones. This was, I think Michael Batnick shared this was the first of, I think the year then, the first time this year on CPI day that the market did not go down.
But all of the emphasis to make it the one positive of the year is being placed on one month over month result, which is such a granular data point. I don’t think anybody would actually make investment decisions off of that. But apparently there are some people acting on that sort of information.
Tim: There’s so many different contrasting data points out there that, to your point case, if you’re making these decisions based on what’s going on every time a new piece of data is released, like you said, last week, this jobs report came out and was way higher than people thought.
And it’s like, there’s no way that the Fed’s going to stop raising rates now, if jobs are growing, because they can continue to raise rates as jobs continue to grow. And that’s ultimately probably they’re going to raise rates that’s going to spill over into an actual recession and it’s not good. And then the market’s sold off.
Then you get the numbers that we’re just talking about, with inflation, and it’s like, “Well, inflation’s not going up anymore. So that’s good. So that means the recession might not be on anymore. So that means we should buy and the market went up.” So, if you’re trying to make heads or tails of these economic data points in real time with your money and your portfolio, I don’t envy that position.
Casey Mullooly: Is good news, good news? Or is good news, bad news? And is bad news, good news?
Casey Mullooly: I think that the narrative was that, if things get worse in the economy, then that means the Fed won’t be able to raise rates for as long as they are signaling that they’re going to do. But if things are good in the economy, then that gives the fed the freedom to continue to raise rates.
Brendan: But even-
Tim: Which ultimately would be a bad thing.
Brendan: Even if things are bad and the Fed is easing off then of the current hiking cycle, they can’t get too bad because then it’s an actual recession. And so, you can try to game these things out, but you’re just layering on if then scenarios and assumptions, and may or may not actually work out that way. So, it’s tough, as Tim said, to make choices based on that. I don’t think that you necessarily should be while-
Tim: You don’t have to, either.
Brendan: You have to be aware of what’s going on, at large, in the market and the economy. But I think there should be more sticking to the script and less reacting to data points like this, because they’re particularly noisy. It’s like if you, to just go back to inflation, month over month, yay. Year over year, boo. Last three years or five years, about right.
Casey Mullooly: Probably not even on anyone’s radar.
Brendan: Even factoring in the last year, let’s say the data points are the monthly data points, but you stretch them back going over 36 months instead of the last 12 months. The last 12 or 13 of them are certainly high, but the other end of this spectrum, that you’re factoring into average out with them from 2019, those were extremely low.
Tim: Very low.
Casey Mullooly: No one knew what inflation was.
Brendan: And then, during the pandemic, through 2020, we had nothing in terms of inflation. So, you averaged all of those out and it’s just shrug, which if you’re looking over longer periods of time with inflation, market returns, GDP, a lot of it is shrug and it’s close to what we expect.
Because if you’re expecting historically what those sort of things have done, and you’re looking over longer periods of time, the longer you’re looking over, the bigger sample size you’re factoring in. And so, the closer the results are actually going to be.
But then if you’re factoring in year to year variance and how those work out, that’s where you can get confused and be like, “Hey, I thought the market averaged 8% a year over the long term. It was up 22 this year” or “It was down 10. What gives?” Well, that average was averaging a hundred years of market history and this was just one data point in that.
Casey Mullooly: Well, that’s what I was going to ask. And I don’t know if you have the exact numbers on this, but how far back, when we’re building inflation into a financial plan that we’re making, how far back does that data go?
Brendan: You can look back over multiple decades and see you had decades with higher rates of inflation and then lower rates of inflation. And so, you can chop it up and be like, “The higher inflation decades average this, how does the plan look mapped with that inflation rate on it?” Or you can just take the long term average, which I think has been something like 2.5%.
Casey Mullooly: So, my point was going to be that, when we look back at stock market data, we usually go back to the 1920s. So we have about a hundred years of data there. And the point being that, the worst and the best markets are baked into those data points.
Casey Mullooly: So, a lot of people have been talking about, “Are we heading back to the seventies? When interest rates were 12, 13, 14, 15, 16% and no one was making money because inflation was just eating away at everything.” But what you’re saying is that those high inflation readings are baked into that 2.5% number that we’re using to build the plans out.
Brendan: And I think it’s good, as advisors, to bring that context to the table while also recognizing that the individual data points do matter. And a year, when you’re living it, does feel like a long time.
So having 8.5% inflation over a rolling year, we all feel that, and it’s not to belittle that. It’s just to say that, we have to plan for the long term and the short term. And so, you got to keep both of them in mind and you have to rightsize them appropriately to make decisions that are reasonable.
Casey Mullooly: And more so that these are things that we’re probably going to have to deal with over 20, 30, 40 years. And I think what we have to do is to just expect that they’re going to happen. And not expect that we’re going to be able to sidestep it or act on it.
Brendan: Agreed. Well, if we expect it, then we were talking about, not necessarily good or bad, but better or worse than expectations. And so, if you have in your mind, the expectation that negatives and positives…
We tend to focus on the positives, especially when we’re talking about market returns, but to bake in and know that historically we’ve had down years, bear markets that happen once every several years and that they’re always on the table and that we can’t predict them ahead of time.
But knowing that it allows it to be better or worse than expectations, you have the ability to set your expectations. So if you can expect and have the context to say that these negatives have happened over time. High inflation has happened historically and it’s baked into this average number.
Down market years, or multi-year periods, have happened and they’re baked into these numbers. And if you expect that, instead of expecting the best, then I think you’ve calibrated that appropriately. And maybe it’s not so bad, even when you’ve been dealt a bad hand in the short term.
Casey Mullooly: I think just having those reference points in your mind when you’re going through these difficult periods can help you get through them and to help you not rip up the script or panic.
And I think that that is valuable data and that’s what we’re trying to do here when we communicate these data points and what we’re thinking and what we’re expecting. So, like I said, the inflation narrative definitely isn’t over.
I wouldn’t be surprised if we’re talking about this for the rest of the year here in 2022, but I think that’s going to wrap it up for episode 404 of the podcast. Thanks as always for listening. And we’ll be back with you next week.
Tom Mullooly is an investment advisor representative with Mullooly Asset Management. All opinions expressed by Tom and his podcast guests are solely their own opinions and do not necessarily reflect the opinions of Mullooly asset management. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of Mullooly Asset Management may maintain positions and securities discussed in this podcast.