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It Only Takes a Few Days

Forecasting the Future

Looking back we can see that 2022 was not a great year for the S&P 500 market index. It was down – 18.11% for the year. 2023 was better with a performance of +24.5%. In fact, we have now surpassed the previous market high that was set on January 3, 2022. But, the question has come up asking why we didn’t see 2022 as a bad year in the making, and why we didn’t get out of investments ahead of it. We understand the question and have some ideas for how to best answer it. By the way, S&P 500 index returns exclude reinvested dividends. Past performance is no guarantee of future results. Indices are unmanaged and cannot be invested into directly.

First, we believe that the markets in 2022 were responding mostly to government policies implemented during the pandemic in 2020 and 2021, that led to the high inflation seen during 2022. There was not the normal recession in the economy that goes along with markets being down almost 20%. As proof of that we can look at our Momentum based investment model, what we refer to as Active Asset Allocation, or AAA. That model has a methodology for predicting recessions and moving away from riskier investments as that recession approaches. Thus, moving away from investments that might lose their momentum. That model never triggered that a potential recession was coming. And for good reason, because we didn’t have a recession. That model, nor any of our other models, are designed to identify or respond to an inflationary environment. So, the one big thing we believe drove the market in 2022 (inflation) was not on our radar until it came and hit, and by then it was too late. None of our research going into 2022 suggested that an inflationary market drop was in the making. The situation seemed to come out of the blue. That’s one explanation for how we missed it.

The second explanation comes from something we believe many people don’t realize about how the markets work. As a narrative develops based on the economic landscape, it takes just a few days over the course of a year to drive market returns. The market goes up and down in a somewhat normal, even predictable way, with the exception of just those few days that drive it in the long run. For instance, in 2019 the market was up +31.2%, but with only 21 trading days making that up. So, out of a normal trading year of 250 days, only 21 days drove the +31.2% return. In 2020, the year of the pandemic, the market was up +18.0%, but that return was driven only two days in that year. Those two days were tied closely to the Pandemic, its narrative and the market lows reached after the pandemic was announced. In 2021 the market was up +28.5%, with only 16 days driving that return. So again, out of 250 trading days, only 16 days were responsible for the positive return. In 2022 the market was down -18.1% with only 5 days making up those losses. Those days align with the inflation-related market narrative. Then in 2023 the market was up +24.5% with only 13 days making that gain. Again, out of 250 trading days in the year, only 13 made up the total return. The point here is that market narratives (good or bad) develop over time and often don’t provide much notice as to what is coming. Given how few days it takes to drive the market up or down, it’s easy to see how it can be missed in market forecast. The vast majority of days do not drive the overall market return.

The point we are trying to make here is that predicting the market and knowing the best way to shift investments can be a challenging process. As we’ve outlined, it takes just a few days over the course of the year to establish the up or down trend. Inflation came and hit the market hard in 2022 and nobody really saw it coming. We did make some tactical changes within our portfolios, but we did not move away from investments more broadly. And it did hurt. But, given that 2021 and 2023 we both very good years, the damage from 2022 was manageable, and one of the reasons why the old saying “it’s not about timing the market, but about time in the market” has proven true over the years.

All the best,
Jim Thibault
Managing Partner

Barron Financial Group, LLP is a fee-only Registered Investment Advisor regulated by the Securities and Exchange Commission.

This newsletter is for general information only and should not be considered investment advice.  Investors should consult with a trained investment professional to discuss their particular situation.

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