Tyler and Craig sit down to discuss how the current market volatility could be used to one’s advantage. We discuss having a personal investment plan before you start investing that is centered around an asset allocation that is suitable to your risk tolerances and return requirements. In the current environment when stocks are selling off you have the ability to buy stocks lower when your allocation falls below your long-term target. Alternatively, when stocks rebound or perform better than your fixed income exposure and your asset allocation to stocks rises above your long-term target you can reduce exposure to equities. This is the proverbial “buy low, sell high” opportunity. It is important from the beginning to find the right allocation as an investor that you only put money at risk that you can afford to. This means investing personal savings in stocks that when they go through periods like we are experiencing today, that you can live with it.
Next, we discuss the current economic and fundamental backdrop for company revenues and earnings. The US economy is still performing strongly on a nominal (before inflation) basis and generally over the long-term is what determines corporate revenues. The S&P 500 earnings grew roughly 10% in the first quarter and current expectations are for continued earnings growth in each of the next three quarters this year and into 2023. Therefore, the current market weakness is being driven by investor psychology. This is supported by the current investor sentiment survey readings which are at low levels indicating poor investor confidence in the stock market. Historically these low readings are a contrarian indicator and returns following these low levels have been positive. The following chart shows the last two-years of quarterly S&P 500 earnings, and the current earnings estimates for each quarter in 2022.
Craig discusses the following chart which illustrates the S&P 500 returns one-year after experiencing a five-month decline greater than 15%. We note that over the past 65 years we have seen 26 five-month periods where the market has declined greater than 15%. 24 of the 26 times (92%) the market has been positive 12 months after the declines. The one-year return has been double-digit during 21 (80%) of those periods. The median return totaled 20% one year later and in only two of those periods did the market continue to decline over the one-year period. If history is any indication, there may be some good opportunities to buy stocks while they are down.
Last, we review the opportunity to improve after-tax returns by harvesting tax losses in a taxable investment account. We discuss swapping an asset selling for a loss for a similar security (i.e., sell Chevron and buy Exxon) as well as a strategy that could take advantage of an upcoming dividend by doubling up on the position and selling the high-cost position after the wash sale period ends 31 days later. Tax losses can be used to offset gains you may have in the account or gains from selling real estate or a business. Annually, you can use $3,000 of capital losses to offset income and you can carryforward any losses above and beyond the $3,000 for future use.