Navigating a Volatile Market with Guest Apollo D. Lupescu, PhD | Episode 1

In this episode, Apollo D. Lupescu, PhD joins Dave Alison to talk about navigating volatile markets. 

We will discuss investor concerns at the moment, including:
Inflation
Fed raising rates
The potential for a recession
Geopolitical risks with China and the war in Ukraine
Tech stocks

...and how we should be thinking about our investments going forward.

To learn more about Alison Wealth Management, please visit our website at:
https://alisonwealth.com

To learn more about Prosperity Capital Advisors or find an advisor in your area, please visit: 
https://prosperitycapitaladvisors.com/advisor-search

The information provided in this presentation is not intended to be individual investment advice or legal advice.  The information provided is for informational and training purposes only.

Investment advisory services are provided through Prosperity Capital Advisors LLC (“PCA”) an investment advisor registered with the United States Securities and Exchange Commission (SEC). For a detailed discussion of PCA and its investment advisory fees, see the firm’s Form ADV and Form CRS on file with the SEC at www.adviserinfo.sec.gov. The views expressed herein represent the opinions of PCA and are not intended to predict or depict performance of any particular investment.

Advisory services are provided through Prosperity Capital Advisors LLC (“PCA”) an investment advisor registered with the United States Securities and Exchange Commission (SEC). Views expressed herein represent the opinions of PCA and are not intended to predict or depict performance of any particular investment.

All data provided, including any reference to specific securities or sectors, is provided for informational purposes and should not be construed as investment advice. It does not constitute an offer, solicitation, or recommendation to purchase any security. Consider your investment objectives, risks, charges and expenses before investing. These views are as of the date of this publication and are subject to change. Past performance is no guarantee of future performance.

Transcript

Dave Alison, CFP®, EA, BPC (00:07):

Hello and welcome to the Complete Wealth Management Podcast. I'm your host, Dave Alison, and I'm super excited to kick off our first episode. We have a great and timely guest, Apollo Lupescu, who is the vice president at Dimensional Fund Advisors, one of the premier investment managers in the world, managing around $600 billion in assets. Apollo is a nationally and internationally recognized speaker who's delivered hundreds of lectures and seminars to financial professionals and individual investors on various investment topics.

(00:45):

Apollo is considered the secretary on explaining stuff because he has a great knack for explaining complicated issues in a clear and understandable way, which is very timely for today's episode, which we're going to talk about navigating turbulent markets. We're going to spend some time talking about inflation, the Fed raising interest rates, the potential for a recession, as well as geopolitical risks with China and the war in Ukraine. We're going to talk about the impact on markets, what we've seen already, what we might expect into the future. We're going to talk about midterm elections and how all of this has an impact on our money and our investments.

(01:31):

Now, Apollo has been with Dimensional in Santa Monica for over 18 years, and prior to that, he taught at the University of California. He received his PhD in economics and finance from UC Santa Barbara, and he also holds a BA in economics from Michigan State University where he competed and coached water polo. Now, rumor has it that even today he's still playing, but more recently, he's not only getting in the swimming pool, but he's learning how to surf out there in Santa Monica. So again, stay tuned for this episode. We're going to gain a lot of insight on the capital markets, on investments, on what's going on in the world, and some great insight from Apollo, somebody I have a tremendous amount of respect for at, again, one of the premier investment managers in the world. Welcome and stay tuned to the Complete Wealth Management Podcast.

(02:36):

Well, thank you so much, Apollo, and welcome to the show today. It's great to have you.

Apollo D. Lupescu, PhD (02:41):

Well, hi, Dave. Thank you so much for the invitation to be part of the show, and thanks to everybody who's taking the time to watch and listen to it.

Dave Alison, CFP®, EA, BPC (02:50):

Absolutely, absolutely. Well, this is our first episode and you are actually the first person at the top of my list I wanted to have on, number one, just because I've been able to follow you over the last 10 years with our working relationship with Dimensional. And I've always been so impressed with your ability to process information and communicate it and simplify it, and obviously your in-depth knowledge of the investments in the markets. You've been so helpful to not only myself but our advisors over the years, and so I appreciate you jumping on. Certainly, a lot going on in the world right now. I know today we want to focus the show on navigating turbulent markets, and the turbulent markets is probably a little bit of an understatement for what we've been seeing this year. So thanks for being here.

Apollo D. Lupescu, PhD (03:41):

It's such a pleasure. I know you and I have worked a lot lately and in the last year or two, and being on this show, it's a true honor, so thank you for the invitation again.

Dave Alison, CFP®, EA, BPC (03:52):

Awesome. Well, let's jump right into it for all the listeners. I think where I'd like to start is that, it just seems like there's no shortage of investor concerns at the moment. Now, between the things with inflation, the Fed raising interest rates, we just had another raise the other day, the potential for a recession, and then of course throw on top of it these geopolitical risks, China, the war in Ukraine. In response, we've seen this steep drop in the market, we've seen much higher volatility. So I guess the overall question is, number one, is it a good time to be invested in the market right now? And for our listeners, what should investors be doing right now or be thinking about right now?

Apollo D. Lupescu, PhD (04:45):

Yeah. You're absolutely right. I mean every time you open the paper, you listen to the news, there's some sort of bad news. And this year was a particularly bad one because it started at the beginning of the year where the invasion of Ukraine and the Russian war, and then it kept going on with inflation and talk of recession. So all these bad news certainly are impacting a lot of folks. And if you are paying attention to the world, if you are paying attention to the US economy, that creates a sense of anxiety. And I'm really starting by acknowledging that. I think it's a part of our everyday life. You go up to the pump or you go to the grocery store and everything seems more expensive. And there's a sense of uncertainty that's had been going on in the country for quite a few months now. So what that tends to create, this anxiety, is exactly the question that you are opposing. Is this a good time to be invested in the market and what should I be doing now given all these realities?

(05:46):

So the place to start for me would be to say, whether or not you should be invested in the market, it depends. It really depends on a fundamental premise, which is having some form of a financial plan. In other words, I cannot tell people, "Go ahead and be invested in the market or don't be invested in the market," because I don't know their situation, I don't know their circumstances. And the best way to really get to that is by having an advisor, like you, and really sit down and identify what are your goals, what are you trying to accomplish with your money, what's important to you in life? And really create that financial plan. What's interesting is that, for some people who are in retirement and they don't have a pension and they're so reliant on their portfolios, perhaps they ought to be invested in the stock market a lot less than somebody who is 35 years old, they have a steady paycheck, and they don't expect to touch their investment portfolios for 30 years.

(06:47):

So whether or not you should be investing in the market, it really, really depends on your personal circumstances, your risk capacity, what are the assets you have and so forth. So that's kind of the first fundamental premise. I don't believe that anybody should tell you you should be invested or not without knowing your specific situation and circumstances. Now, about the US market being dropped. So let's just say that you need to be invested in the market, should you now be in the US market with all the bad news that have happening? The unequivocal answer, in my opinion, it is yes, you should be invested. If you need to have a portion of your money allocated to the stock market, you should absolutely be invested at this moment in time. And I'll give you a few reasons why I think that we believe it's the right approach.

(07:36):

The first reason is that quite often we see that these emotions are really driving the decision to get out of the market. "I'm anxious. I don't like the way things are going. I'm not really looking at data, but just emotionally I feel that way." And there's so much evidence that the human behavior has an impact in the way that we make decisions. I mean the stock market, it is not always in our best interest. A lot of people feel comfortable when the market goes up and up and up, and that's when they're comfortable buying, but you're buying at a pretty high level at that point. And then when the markets drop and fear settles in, that's when they sell. So selling at the bottom and buying on top, it's exactly the opposite of what investors should be doing. So in my opinion, the first thing you have to acknowledge that there's an emotional component because of all the bad things that have happened.

(08:28):

Secondly, what we're seeing right now is that the confluence of events that he mentioned have led to the market to already dropped. In other words, the market is not dropping, it's dropped already. So all these negative news that we hear in the world, all these events that are impacting negatively the economy, it seems like a lot of those have already been priced in the market, and that's where we see the markets drop for the year. Now, what's going to happen going forward? It's really not known. The news of tomorrow could be good news or bad news, but we don't suggest that people sell just because the market is already dropped up until this point.

(09:14):

The next reason I think people have to be careful about selling is that whenever you decide to sell, there are taxes that you might have to pay, there might be transaction costs, but most importantly, you also have to make an equally important decision at the same time. When do you get back in the market? And that's been a problem that has plagued, everybody was trying to move in and out of the market. You might decide it's time to leave. The problem is that nobody can tell you when is it the right time to come back. What we see over and over with investors is that they sell particularly after the markets dropped, and the stress of being invested in the market is very quickly replaced by the stress of being out of the market. Because if they see the market rebound and they're sitting in cash, they keep wondering, "When do I get back in? Am I missing the rebound?"

(10:12):

So far, there's so much evidence that people who react on these emotions and they sell, they tend to continue to have stress one way or another. I mean, look at 2020, we had that huge drop in a few weeks. The S&P 500 Index dropped by about a third in value, and so many people were afraid of what the pandemic might do and how scary those days were. And if they sold, the trouble is that the market started a huge rebound right after that, it ended a year quite positively, and a lot of investors missed that rebound because they did not know when to get back in the market. So that's a really important consideration.

(10:52):

And lastly, particularly because the market is already dropped, you look at the history and what you see is that really successful investors have a program in place, something that's systematic, a process in place where they actually look on a relative basis and see what investments have gone up in value and what investments have gone down. And interesting enough, instead of panicking and selling the investments that have lost value, or instead of just holding onto the investments that have shut the lights out, what they do is, they trim the gains and they buy whatever one downing valuation and do that through a very systematic process called rebalancing. I know that you folks have a process like that. Basically, what it means is that I'm going to sell high and buy low. And what it means right now, as the market has dropped, instead of looking at it and saying, "Wow, this is a disaster," I think a better way to look at it is perhaps this is an opportunity. It is an opportunity to buy at valuations that are better today than they were six months ago.

Dave Alison, CFP®, EA, BPC (11:57):

Yeah, that's great feedback. I've seen a couple things. Apollo, as you know, everything for us starts with the financial plan. And when we time segment money based on the purpose, the liquidity, the time horizon, into those three simple buckets, the now bucket is your safe and liquid money, it's generally your expenses for the next year. We don't know what the stock market's going to do in 12 months, and so it's off the table because it's your spendable money and your emergency fund. The soon bucket is any money you may need sooner rather than later. So your example, somebody approaching or in retirement might need five or 10 years worth of supplemental retirement income in that soon bucket, and maybe they shouldn't be fully invested in the stock market with that money because of the big ups and downs that it could experience. And then the later bucket is where we have a long-term time horizon. We have 10 plus years to confidently have that money invested for long-term growth.

(12:58):

So everything starts with the plan, but it's always interesting because the human emotion, I mean we all hate losing money, we all hate seeing our account balances go down. And there's a lot of great studies out there on risk aversion. People hate losing more than they like winning. That's what drove all the greatest athletes in the world. Michael Jordan didn't care about winning a game, but man, he sure hated when he lost a game. And that's what I kind of feel like we sometimes react to with our portfolios, particularly like the comment I've gotten from clients of, "Hey, should we get out of the market right now? Let's just wait until things calm back down a little bit before we get back in." And it's like, "Well, by the time things have calmed down, the market's already fully rebound and you missed that recovery." So, absolutely kind of playing into what you're talking about there.

Apollo D. Lupescu, PhD (13:51):

Yeah. That speaks so much of the role of the advisor because whether it's creating the buckets or basically having a coach when things look tough and you feel like making these decisions, having somebody to give you a trusted second opinion, I think it's fundamental. And helping you stick to those plan because you have these buckets, I think it's really the key to this problem. It's not an investment problem, it's a people problem. Having an advisor as a coach, I think it's an incredibly powerful voice to have with you.

Dave Alison, CFP®, EA, BPC (14:27):

That's great. I want to dive a little bit further into some of these themes that are going on in the world right now. The first one is what none of us could ignore, every time I turn on the TV, there's comments about the Fed, Fed's decision, and interest rates. I have two clients that were trying to build houses and they just got quoted a seven and a quarter percent mortgage, which for anyone who's bought a house in the last 10 years, that seems astronomical, but historically, maybe it's not too, too bad, but we've heard a lot about the Fed raising interest rates over the past months. It's going to continue to hurt consumers, hurt businesses. It's going to potentially lead us into an economic recession. What are some of your perspectives on why the Fed is taking these actions and the overall impact of this?

Apollo D. Lupescu, PhD (15:20):

Yeah, no, even as you said yesterday, there was news of another hike in interest rates by the Fed. So it's a good way to think about it like, "Why is the Fed doing this knowing that we're hurting consumers, we're hurting businesses? What's the background?" I think it's important to maybe take a step back and really see the reason for this and understand where it came from. And to do that, Dave, let's go back in a time machine to the early '70s, that's kind of when I was born, roughly in that timeframe. A little before that, but I was a baby when the whole thing was going down.

(15:58):

Back in the early '70s, there was a really interesting period when there was a realization that the way that the money worked up until that point, it was not really the best way forward. And what do I mean by that? Up until the early '70s, in order for the US government to print another dollar bill, it had to have gold in the bank. That is something that was called the gold standard, meaning that you can always take your dollars to bank and get a certain amount of gold for those dollars. The gold standard gave a lot of people the confidence that hey, the money has value because it's backed up by gold. The trouble was that as the economy got bigger, as we had more people in the country, it wasn't sustainable. You needed more dollar bills, actual physical dollar bills as the economy grew and grew.

(16:50):

So in 1971, President Nixon cut that link between the dollar and gold. So in 1971, we got away from the gold standard, and since then we have a different type of money called fiat money, which means that the money is not backed out by anything, by any gold, or any precious metal. Really, it has value because we all collectively believe that the money has value. But Dave, if you take yourself in the time machine, I wonder how we would've felt today if we were told that the US government now does not have any restrictions in printing money, that you can run the printing machines that night, there's no backstop, and the government can flood the economy with dollars. Back in those days, just talking to people who lived those days, there was a great sense of anxiety that money will have no value, that we'll have rampant inflation. And this is going to be horrific because, again, there is no backstop to the government printing money.

(17:56):

At the same time, roughly, we had a second big event, which was the OPEC, Organization of Petroleum Exporting Countries, really to show their displeasure with the US policies in the Middle East. They actually put an oil embargo against the US, and we had a huge energy shock in the early '70s when we did not receive the Middle East in oil. And at the time, we're so dependent on that oil. That was the very first time when that happened, that the words energy, independence were ever uttered. So to me, we had a second situation where the oil crisis made everything run so badly in the economy, not only that oil got very expensive, but there were shortages. We didn't have enough oil at the pump.

(18:47):

So there was a second thing that compounded the anxieties around the transitions from the gold standard to the type of money that we have to do, the fiat money. And the third event, there was a global route that really impacted food, and we had big shortages of food around the world. So when these three events happen in the same time in the early '70s, one of the things that we saw where prices just start to go up and up and up and up. In the early '70s, we had inflation that was even higher than we have today. And the thing is that when that inflation happened, economists try to figure out how do we bring this inflation out of control? And what they figured out is that the Federal Reserve has a very powerful tool, that if the Federal Reserve starts to increase the interest rates in the economy, well, businesses will actually start reducing their spending because it's more expensive for them to build a warehouse or to invest money in whatever project.

(19:48):

Consumers will also be impacted because, as you said, if mortgages become more expensive, well, they're going to have less money to spend on other things. And if you reduce demand from the consumers and the businesses, what happens is, you also reduce the pressure on prices. The flip side is that, as you reduce demand, companies will not produce as much and that might cause economic pain. In fact, as prices started to come down but there's some economic pain because of these higher rates, the central bank in the US, the Fed, actually reversed course throughout the '70s. As soon as the economic pain was felt a little bit, they just said, "No, no, we're going to cut the interest rates." And then at that point inflation stayed high.

(20:32):

Here's the thing: It wasn't just the idea of the supply and demand that he can measure, but there's something other very meaningful that happened in those days, which was the behavioral element, the fact that we are human. Everybody in society started to believe collectively and form an expectation that inflation will stay high. And when you start forming that expectation, if you are a union and you are negotiating a contract, well, you're going to say, "I think inflation is going to be high. So why don't we bake in a 10% per year increasing pay, year after year, because the expectation is that inflation will stay high?" If you're negotiating contract with your suppliers, the suppliers might bake in a 10% increase, whatever the loan might be. And at that point, that expectation will make inflation a self-fulfilling prophecy. And that's exactly what happened in the '70s. For all the decade, basically the expectation led contracts and businesses to put in a pretty high inflation, which became the norm in the '70s. And that's why the entire decade was quite high inflation.

(21:46):

Now, in the late '70s, a new Fed chairman came along, his name was Paul Volcker, and when he came, he kind of said, "No, no, we're not going to mess around with this anymore. We're actually going to stick to a higher interest rate and keep rates high and reduce the economic activity. We know that that's going to be the case, but it's a trade off and we're actually are willing to stick with this. And even if we cause severe economic pain, the damage for high inflation for years to come, it's a lot greater." So he stuck with it, and what Paul Volcker did, he convinced the society, businesses, unions, consumers, that the Fed is serious about fighting inflation even though we might cause economic pain, and we did some pretty big recessions in the late '70s and early '80s.

(22:33):

What happened though within a couple of years or so, two or three years, all these expectations started to get reset and inflation started to drop. And for the past 40 years or so, we have not had an issue with inflation. Part of it was because the Fed sent that very clear message and reassured everybody that it will do what it takes to fight inflation. So today, fast forward to 2022, we do have pretty high inflation. So the Fed is put into this position now where he has a trade off to make. What do we do? Do we increase interest rates knowing there might be some economic pain, and at the back of this economic pain, we're going to resume the low inflation that we've had? Or do we not fight the inflation and keep the economy humming along with the much greater risk of seeing high inflation being the norm and then the potential trouble that might cause down the road?

(23:29):

What we've learned is that you just have to choose between the two evils. Right now what the Fed is doing is really sending a very strong signal that we will do whatever it takes to fight inflation, even if it causes economic pain, because this economic pain, at least if you look at the 1980s, was in the neighborhood of maybe two or three years and then we didn't really have any issue with inflations for decades. And it's possible that we might actually not end up in a recession. We don't know that yet, but at least that's kind of why you're seeing what you're seeing.

(24:03):

So it's the Fed having to choose between two evils of trying to pick the lesser one and using the experience that we had in the '70s and not repeat the mistake of not being serious about fighting inflation, but rather look and see how we get rid of it last time, which was by increasing rates. I mean we talk about 7% mortgage rates. I was talking to my mother-in-law not too long ago, and when she bought a house in the '80s, her house, I think her interest rate was something in 18% or something like that. So when you talk about 7%-

Dave Alison, CFP®, EA, BPC (24:35):

I was talking to the client last night about the 7% interest rate, and the difference is, call it the risk-free rate, government T bills or treasuries are paying around 4% right now. So a year ago, mortgage rates were three or 4%, but the risk-free rate was pretty darn close to zero back then. So, kind of a rising tide has lifted all ships there.

Apollo D. Lupescu, PhD (25:04):

That's exactly right. And you kind of point out something very important, is that these higher rates are a benefit to savers, but they are really costly to borrowers. So it really depends. Rates going up really depends on what side you are. If you're a lender, then actually that's a good thing. And if you're a saver, that's a good thing. If you're a borrower, that's certainly not much. So whether the rates going up is good or bad for you, it really depends. It's not universal, everybody gets hurt, not at all. As you pointed out, savers are now making a lot more on their money, if they're investing-

Dave Alison, CFP®, EA, BPC (25:39):

I want to bring it back around to what we were talking about at the opening though. Obviously, the economy could be in for harder times with these interest rate raises. And you alluded to some of the things that happened in the late '70s, the word recession keeps coming up, whether we're in one already or maybe we're heading towards one in 2023 or we never see one. The overall impact to the stock market though, because obviously that impacts our client's investment balances, is this kind of high or low inflation, high or low interest rate really, really impactful statistically to the stock market performance?

(26:20):

And maybe a different way of saying that is, as you mentioned earlier, the stock market has already dropped because it's pricing in future expectations of the economy, these companies, their ability to deliver earnings. So would you say it's fair to say that at least a lot of this information as we know it today, without any future surprises, is somewhat priced in to the efficiency of the stock market as a whole? Or is this, again, you're not the only one that knows of this information, I would imagine?

Apollo D. Lupescu, PhD (26:58):

Yeah, yeah, absolutely. I think you hit it. A lot of the market participants, really not only that they take account of all this information, it's not like they're ignoring, they just came from an island somewhere in The Bahamas and they just, "Hey, what's been going on? Oh, the Fed is raising rates, let's go sell some stocks." Of course this information is available, this information is priced in, but he also says something that's really important, the stock market is about ownership in companies, and the value of the ownership, to the point that he made, is exactly based on what expectations do investors have about future earnings, future profits, because that translates into the cash flows that they might get. So to me, the stock market is really about the expectations of earnings and cash flows.

(27:51):

So when you think of the interest rate in that respect and the Fed raising rates, noting that the market prices it in, but there's a second element to this which is asking the question, well, how meaningful is this increase to the expectations of profits? Certainly it's one of the many, many variables that impacts the market, but the question is, is this somehow what I think of as a primary variable where the increase in rates is directly linked to a dropped in the market because so many companies are having to pay more in interest and that might not be good for them? So there's no doubt in my mind that the Fed raising rates, it makes it more expensive for companies to borrow. The question is, among all the other variables, and we talked about China, we talked about supply chains, we're talking about a Russian invasion of Ukraine, we talked about COVID protocols and all that, when you put this in the context, is the increase in rates by the Fed a primary variable that leads to the market to drop?

(28:57):

If you go back 20 plus years, so we'll just go back 20 plus years, we can go longer, but just to get a sense of this, at the beginning of the century in 2000, the federal funds rate, which is the one rate that the Fed really controls directly, was up quite high about six and a half percent. Over the course of a few years, we had the tech bust and we had the recessions in a one or so, the Fed lowered the interest rate to about 1%.

(29:29):

But here's something interesting, Dave, is that we had a period between 2004 and 2006, where three years, we had back to back to back increases in interest rate by the Federal Reserve. And that could be a case study of analyzing what the market does when rates do go up. But it went off for about 1% to over 5%, so it was a pretty steep increase in rates over three years. And then just as we had the financial crisis, the rates came back down to almost zero for many, many years. But what's also interesting is, we had another period between 2016 and 2018 with another three years of back to back to back increases in the Fed's fund rate, and then a draw back to about zero for when the pandemic hit. And today it's on its way up.

(30:25):

So the question now becomes, if you look at these two case studies at '04 to '06 and '16 to '18, what can we learn about what the market does when the Fed increases rates? So on the first period, let's take year by year, in 2004, the S&P 500, which is a broad measure of the US market, was up 10.9%, which is roughly the long-term average. In the second year in '05, it was up about 4.9%, and in the third year, it was up 15.8%. So what's so interesting is that even though we have three years of back to back to back significant increases in the interest rate in every single one of those years, the US stock market also went up, which is a little bit contrary to the narrative that exist right now in the media.

(31:20):

And then you look at the second case study, which was '16 to '18, in 2016, the market was up about 12%, which is above the long-term average; in 2017, 21.8, which is more than twice the long-term average; and in 2018, interestingly enough, we did have a negative year in the market with negative 4.4%. What's interesting is that when I look at these case studies, what it seems to me is that there is no clear evidence, there is no clear evidence to suggest that as interest rates go up, the market automatically will go down. Not at all. In fact, five out of the last six years when we had this rising rate environment, the market also went up, one in six, it did go down. So it's possible the market would go down.

(32:10):

But to me, ultimately draw us back to that idea that the interest rates and particularly the Fed fund rate moves is certainly incorporated in prices. And also at the same time, it appears to be one of the many, many, many variables impacting the stock market, just not a primary one where you can directly link what interest rates do with the performance of the stock market. And because of that, I think it's another one of the situations where between the fact that markets already incorporated this and it's not a primary variable, we don't really think that the Fed increasing or decreasing rates should be the sole reason of making a move in your portfolio.

Dave Alison, CFP®, EA, BPC (32:55):

Gotcha. Very helpful. Just kind of closing up this whole interest rate conversation here because it certainly has been the highlight of all the media and the news over the last six to eight months. One of the things that we've seen, at least over the last decade, is this kind of near zero interest rate environment has created so much capital available at next to nothing in terms of cost for companies to really accelerate and grow. Particularly, if you look at the tech sector over the last 10 years, a lot of my clients have been major benefactors over working at these tech companies accumulating wealth because of these skyrocketing valuations. So as you see these interest rates increase, you mentioned already borrowing becomes more expensive, the times are changing a little bit in terms of that dynamic, is there any specific impact that that action might have on the stock market, or any other asset classes individually? Will be able to grow like it used to, and not that you have a crystal ball, I wish we all did, but is there anything you're seeing or thinking about in regards to that?

Apollo D. Lupescu, PhD (34:09):

Yeah. It's a really important question. So when I think about the stock market, this is my personal view, is that I think a lot of these, particularly if we talk about in the tech companies, it's not clear to me to what degree they are using borrowing and to what degree they're incurring a huge cost because of these higher borrowing cost. In other words, when you look at companies that are really dominant in the market, you look at Apple, you look at Microsoft, you look at Google, you look at Amazon, you look at even Tesla for that matter, and even Facebook, a lot of these companies, they're profitable. It's not like the tech stocks of the '90s where they're losing money left and right, these are profitable companies. They are generating excess cash flow. A lot of times that's being sent back to investors like in the case of Apple with dividends and so forth.

(35:11):

So what is their actual need to borrow? That's kind of up for the debate, particularly for the large tech stocks. So will they really take a big hit? They certainly need to borrow, but in the bigger scheme of things, how expensive and then how impactful is the additional expense of borrowing on their bottom line? And again, without re-looking at all the data, my intuition tells me, is that it's not as heavy, it's not impacting them directly as much as one might think. So that's my personal view, is that the tech companies today, by being profitable, by having excess cash, they really relied that much on the borrowing. And that might be for other companies, but I don't see that. They also have the ability to raise equity, if they really want to avoid the borrowing.

(36:07):

What I do see is that there's another asset class that's being impacted quite meaningfully right now, and that is bonds. So when you think about stocks, it's about ownership in companies and the profits they make. Bonds, on the other hand, are about lending. And as an investor, you can lend your capital to governments and corporations in the form of these bonds. And what happens is, if you had, for example, lend your money to the US government and you bought some bonds at the beginning of the year at let's say 1% interest rate, and now you go look and say, "Well, the similar government bond is paying 4%," well at that point, the impact of these increasing rates could be quite significant if you are trying to sell the bonds that you bought at the beginning of the year.

(37:01):

So if you try to sell that 1% bond today, when bonds are paying 4%, all the market's going to say, "I'm not going to pay you full price because your bond only pays 1%, the new ones pay 4%." So that's when you see that bond holders have actually seen pretty significant losses on their statements because of these increases in rates. So I think that the bond holders have been much more significantly and directly impacted by the higher rates rather than the stock market and particularly the tech stocks in the market.

Dave Alison, CFP®, EA, BPC (37:39):

Absolutely, absolutely. Well, Apollo, this has been great so far. I have two more questions for you as we land the plane here. The first one I want to talk about is what we have coming right around the corner in the US, which is midterm elections. And then I just want to hear, as we close out, things that you might be optimistic about or things that maybe bring you confidence in sort of a doom and gloom world that we live in right now if you turn on the media. So let's just hit on midterm elections real quick. And I know we're going to be hearing more and more discussions about the impact on various policies and proposals and what happens if we have one party or another controlling Congress or the White House. What are your thoughts on that? And what are you hearing and talking about with others?

Apollo D. Lupescu, PhD (38:27):

Yeah. And it's up, so it's a big news of the day. We're a few days away from the midterms. And we've looked at the data. First of all, Dave, I think that politics, it is an incredibly emotional subject because it touches on our core identity as individuals, our deeply held beliefs. And I think it's absolutely fine to have these emotions because that's what makes us human. I think the way we ought to express them is by voting. Go out there and vote your personal views. What I want to talk about is almost like disentangling these emotions which are so personal from investment decisions with money. Because what we find is that it's good to acknowledge these emotions, at the same time, when we talk about decisions about money, it should be on a much more pragmatic view that's based on data and evidence.

(39:25):

I think it's important. I'm not here to make anybody feel good or bad about their views, they're personal. What I want to talk about is the data. What does the data say about elections in these midterm years? So what we found is that, interesting enough, if you go back to the 1920s, and we've had 24 different midterm elections, and about 15 of them have been positive, 15 years when the market went up in a midterm election and about nine of them that went down. So it's a combination of both positive and negatives. There are more years that are positive than negatives, which is a good thing. And on an average, what you see is that the market in that midterm election year went up by 8.6%. So on average, we do see that the positive years outweigh the negative and the average is positive.

(40:18):

The highest we saw was in 1954, it was a 52% return, and the lowest was in 1974 at a 26% negative. A lot going on, by the way, 1974 as we talked about it. But what's fascinating is that if you look at the quarter, the fourth quarter, and this is when the election actually happens, what you see is a pretty stunningly high average of 6.5%. So historically, on average, during the quarter of the election, not the first quarter of the year, but the quarter of the election, we saw a 6.5% increase in the S&P 500 going back to 1920s. And if you think that the overall average for the year is 8.6, then it seems like a lot of the best part of the year was in Q4.

(41:03):

Now, we're getting close to the end of the year, what about the following years? So when you look at the year following the midterms, now that gets interesting because out of the 24 election midterm years, we only had two negative years, only two negative years: 1931 when we had the Great Depression, and then 1939 when we had Germany invading Poland and the beginning of World War II. Those are the only two negative years following a midterm election, and the rest of the 22 out of the 24, they were positive. So again, some really just encouraging news that there is no evidence to suggest that, boy, just because we're in a midterm election, that's going to be a terrible outcome for the market.

(41:51):

But the one thing that I want to maybe take a look at is, we're right now in a situation where, at least for the past couple of years, we had this natural experiment, Dave, where we had one party in control of the White House, the Senate, and the House. And that is something that some will refer to as the unified government control, not unified, because they're holding hands, unified because the one party controls the White House, the Senate, and the House. Right now it's the Democrats. And we wanted to know, well, did the Republicans at some point during the 1920s to the end of 2020, did they have that as well? Because they would make it a very natural experiment to see how the market does when we have one party in control versus the other one in control. And this is like full control in Washington.

(42:45):

So when you run the numbers, what we found is that, the Republicans from 1926, they had 13 years of unified government control, when they had the White House, the Senate, and the House. And on average, during these 13 years of Republican unified government control, the market went up by 14.52%. This is just a simple average of the 13 years they had control. Now, the Democrats also had it. Yes. And is it for longer or shorter? Well, we ran the data and we found that the Democrats had it for longer. 34 years, they had this unified government control with the White House, the Senate, and the House. And what was fascinating then, Dave, is that over these 34 years, we ran the average over and over and we had PhDs running numbers, and the answer is that during these 34 years, the average market return during the Democratic unified government control was 14.52%. It is identical to the second decimal to the Republican outcome.

Dave Alison, CFP®, EA, BPC (43:56):

Wow.

Apollo D. Lupescu, PhD (43:56):

It was such a fascinating result because ultimately, it drives home to the same point that in a way we talked about at the Fed. Politics certainly plays a role with companies, and for sure they have to navigate the politics. But what's interesting to me is that when you look at the data, to the second decimal, that does not appear to be a difference between how the market does during Republicans or Democrats. And what it means to me is that politics, same as the Fed, is a variable that impacts the market, and who controls the government is certainly a variable that might impact the market. It just doesn't appear to be a primary variable that we can point and say, "Aha, we have one party or the other, the market's going to do bad or is going to do well." Not at all.

(44:43):

It seems that the market charts its course. Whether it's Republican or Democrats, the profits of the companies, they tend to be much more dependent on the company's own strategy, their products, the execution, what competitors do, much more so than who's in charge in DC. So the ultimate answer is, similar to what we saw in the Fed, is that we ought to pay attention as individuals to the elections, vote our emotions, our conscious. When it comes to money, it does not appear to be a variable that would indicate that we need to buy or sell solely because of that reason.

Dave Alison, CFP®, EA, BPC (45:23):

That's some great research and definitely something to be optimistic about with some of the positive data after a midterm year. You shared something with me a few weeks ago also, and I don't know if you have the exact statistics off the top of your head, but you shared that anytime we've seen a market drop of 20%, regardless of how much further the market has dropped from that point, we've seen pretty strong positive returns within the following 12 months.

Apollo D. Lupescu, PhD (45:56):

Yes, absolutely.

Dave Alison, CFP®, EA, BPC (45:56):

Do you have that? You just shared that stat-

Apollo D. Lupescu, PhD (45:57):

Yeah, absolutely. That's really important data. And what we talked about a couple of weeks ago was basically just looking at the nature of the stock market in the US. I think that's a good starting place because we see this 20% drop and a lot of folks are saying, "Wow, this is terrible. It's very tough to handle." And what we wanted to do is look at the history of the US stock market and really present it to an investor as a sequence of bull markets and bear markets. Because we see this 20% drop, the question is, have we seen the 20% drop historically in the US market?

(46:38):

So when you look at the history of the S&P 500 going back to 1920s, what you see is that there are periods when we see a bear market, which typically is considered to be a 20% downturn. And you certainly see there are also long periods of bull market, which is when the market goes up. What this chart and what the fundamental data shows are two things: One is that bear markets happen. It's not unusual at all to see bear markets. What's interesting about these bear markets is, number one, they tend not to last as long as bear markets. It's clear, clear, clear from the data that the bear markets don't last as long. The last bear market we had, as I mentioned, was two years ago in 2020, and it was a drop of 34%, but it lasted one month. That was the bear market. We look in 2008, where we had a bear market that lasted 13 months and then shortly after another two months. So these bear markets, if you compare them to the bull markets, well they lasted 155 months, 153 months, 62 months, certainly a lot longer.

(47:55):

So the first comment to make is that the market's dropping 20%. It is something that we have seen in the past, and it's part of the nature of the stock market, the fluctuating value, because of business cycles, because of all the things going on in the world. But secondly, it's also important to know that there is no clear pattern. If you look historically, there is no pattern to tell you that after a certain amount of the bull market, the bear market's going to come or the bear market's going to last a certain amount of time. Look, the last one lasted one month, the one before that lasted two months. You can have 21 months or three months. So they do last in an unpredictable sequence. And to me, that's a reason to say maybe getting in out of the market based on what's called technical analysis is not worth much. It's because they do come in unpredictable patterns. So the first thing to note is that bear markets don't last as long as bull markets. And also, bear markets come at unpredictable pat in unpredictable patterns and lengths of time.

(49:00):

Now the question that you asked, Dave, which is so important, okay, great, we've seen this bear market, now what do we expect next? Now that we saw this 20% drop, what do we expect next as investors, let's say, over the next year or so? We looked at exactly that data, and we took a 20% downturn in the market and we asked the question, after you see this 20% decline, what happens one year looking ahead? And what's fascinating is that on average, on average, one year after the market dropped 20%, the really great news for investors is, on average, the market does not continue to slide, but actually it goes up. And in this case, it went out by about 22% on average.

(49:44):

So let's just kind of clarify that. So the market drops by 20%, what do you expect about a year after? On average, the market goes up by 22%. When you fast forward three years, the market goes up by about 41% after three years from that 20% decline. And after five years, it's up about 71% on average. So the great news I think, Dave, based on what you mentioned, is that we saw this 20%, it's happened. And what's interesting is that on average, one, three or five years, your portfolio is going to be actually getting close to being on track and going to the long-term averages, which are positive rather than continued pain through more negative outcomes.

Dave Alison, CFP®, EA, BPC (50:35):

All right. So we've been talking about all this, Apollo, and I guess I would ask you, with the confidence of the things that you shared, what does make this different this time?

Apollo D. Lupescu, PhD (50:47):

Yeah. It is different, Dave, there's no reason to sugarcoat. This particular confluence of events, with the war Ukraine, the inflation, the COVID, the China, the supply chains, all these things are making this situation unique. And there's no reason to say that it's not different. It is different this time. I thought about this, and what exactly does it mean to be different? The one thing that popped to mind is that since the pandemic, I picked up chess again. I have an app on my phone and I play some games or chess. And what struck me was that every time I play a game, the position in which I end up is different from game to game. I have not played two games where I ended up in exactly the same position. So to me, it kind of got me thinking that the situation we are in, it is different as every game of chess is different in the way that it ends up in the position in which it ends. So to me, the fact that we are different, it's absolutely acknowledgeable, and it's the same as a game of chess.

(51:52):

The thing is, in chess there's a fundamental premise. You have a board, it has 64 squares, the same pieces. What is that fundamental premise today that is the same even as this confluence of events might be different than what we've seen in the past? To me, Dave, the fundamental board on which we play, the fundamental thing that is still the same in the market, is the fact that we operate in free markets, that we live in a capitalist society, and in this world that we live in, companies are resilient and they will find a way to make it work irrespective of the current conditions. We've seen this over the years in so many situations. Company have been through World War II. They have been through the '70s, they've been through the '80s. All these things that have happened in the world, companies will try to find a way to make it work. So my optimism comes from the fact that in free markets, companies will find a way to adjust and innovate based on the conditions that we might be in.

(53:01):

A few years ago, if you remember, when we started the pandemic, the stories actually switched from brewing spirits to doing hand sanitizer. Online vacation websites, they move from selling homes on the beach to basically, "Hey, here's a place where you can work." And they found a way to make it work. I mean look at World War II, companies like auto companies, instead of making cars, they transition to manufacturing tanks and airplanes for the army and they would sell them to the US government. So to me, really the optimism is that the fundamental board, the fundamental premise that we live in is still the same, that companies will find a way to navigate these times. We've seen it over and over and over again, and there's no reason to believe that that resilience is over. On the contrary, I think the companies are more resilient now than ever. And that really gives you the optimism that we're going to go through this period, we'll navigate it. And being part of the stock market would allow us to capture these opportunities through these great American companies.

Dave Alison, CFP®, EA, BPC (54:07):

Absolutely. I mean, just look at some of the last downturn and some of the biggest companies in the world that have emerged out of them, whether it was the dotcom bubble with Amazon and PayPal or the 2008, '09 crisis with companies like Facebook and others. And there's no doubt, through this one, more will emerge, which continues to show your point earlier, now is a great time to be an investor if you have the right time horizon and the right financial plan. Well, that's definitely something to give us all confidence in this uncertain market.

(54:37):

So I have one more really important question for you. You live in a beautiful area, Santa Monica. A lot of our clients are big travelers. If they come to Santa Monica, I'll put you on the spot, what's the number one thing they need to go check out, number one place they need to go to a restaurant? Where's the local hotspot, if you were there, to give some real good advice to our clients, lifestyle advice here?

Apollo D. Lupescu, PhD (55:03):

I would say try where the locals go. There's a street that was revamped and it's called Abbott Kinney in Venice, which is very close to Venice Beach. It's very close to Santa Monica. And if you're going in for dinner, I would say there's a local's restaurant called Gjelina that tends to actually give you a flavor of the local California cuisine. And if you are looking for breakfast, right next to Venice Beach, there is this Australian little cafe called the Great White, and that's a great breakfast coffee type of place. If you're looking for drinks, there's a place called Hotel Erwin across the street from the Great White. They have a great rooftop patio. You get to see beautiful, beautiful sunsets from the rooftop and a great view of the entire Los Angeles basin.

(55:56):

But don't forget, if you do come here and if you're not local, it's probably worth booking, just for kicks, a surf lesson because it's kind of fun to go back and say, "I tried something new." And a lot of folks here in Southern California do surf. If you have time, go to the beach, take a surf lesson, get a bike, and then there's a beautiful strand that you can ride your bike or go for a run.

Dave Alison, CFP®, EA, BPC (56:22):

Awesome. Well, what a good bookend because I started your introduction talking about your competition and coaching in water polo, and you're now in the ocean getting your surfing on. So go out to Santa Monica, try out surfing, maybe you'll see Apollo out in the ocean or one of those great spots. Apollo, this was awesome. I really appreciate you jumping on here with us and all the great support you provide to us and our advisors over the years. Thanks so much. Any final thoughts on your end?

Apollo D. Lupescu, PhD (56:51):

Well, Dave, it was great, great fun talking to you. Thanks for having us. I want to go back for a hundredth episode of this podcast, so best of luck with this new podcast.

Dave Alison, CFP®, EA, BPC (57:06):

Awesome. Thanks so much. I appreciate it. Have a great day.

Apollo D. Lupescu, PhD (57:10):

Bye-bye.

Speaker 3 (57:10):

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