MIKE TOWNSEND: Talking to investors over the last few weeks, the most common feeling I've heard is a mixture of uncertainty and anxiety about what's going on in the markets and the economy. In the first quarter of 2024, the S&P 500® rose by 10%―a banger of a quarter, as my kids would say. Since the second quarter started, the S&P has given back a third of that first-quarter gain.
Economic data, meanwhile, continues to perplex. The unemployment rate remains near historic lows at 3.8%. But inflation has been sticky. While it has dropped precipitously since its 2022 high of more than 9%, it remains above the Federal Reserve's target of 2%, ticking up a bit last month to 3.5%. The Fed, taking all this in, has kept the federal funds rate steady for five straight meetings. Under the "higher for longer" mantra, market expectations for four to six rate cuts at the beginning of the year have moderated significantly, with the market now expecting one to two rate cuts this year, and many analysts raising the possibility that the Fed won't cut rates at all in 2024.
For a lot of investors, these various data points just don't quite line up with each other―and that's the root cause of quite a bit of the uncertainty and anxiety.
Welcome to WashingtonWise, a podcast for investors from Charles Schwab. I'm your host, Mike Townsend, and on this show, our goal is to cut through the noise and confusion of the nation's capital and help investors figure out what's really worth paying attention to.
Coming up, I'm going to welcome back to the podcast Kevin Gordon, senior investment strategist at the Schwab Center for Financial Research, for a really interesting discussion on the state of the economy and the markets. We're going to dive into what the latest data is telling us, why it sometimes feels like the different data points are in conflict with each other, and what it all may mean for the investors.
But first, here are my three things to know about what's going on in Washington right now.
First up, the months-long stalemate over funding day-to-day government operations may be over, but that has only put the spotlight back on a different federal spending fight―the ongoing one over emergency foreign aid.
Back in February, a strong bipartisan majority in the Senate passed a $95 billion package to provide funding for Ukraine, Israel, and Taiwan, as well as a substantial amount of humanitarian aid for civilian victims of the wars in Gaza, Ukraine, and other international hotspots. But that aid package has not been brought to a vote in the House of Representatives because of frustration among some Republicans that it prioritizes foreign assistance over focusing on domestic issues, like securing the southern border.
In recent weeks, however, House Speaker Mike Johnson has said that he will bring a Ukraine aid bill to the House floor that includes other unrelated provisions―though he did not spell out exactly what those provisions would be. But the clear implication was to break up the Senate aid package into pieces. And it seemed, for at least the past couple of weeks, that the House was inching toward prioritizing aid for Ukraine.
Over the weekend, however, Iran staged a largely ineffective drone and missile assault on Israel, and that has shifted priorities and may be the catalyst that breaks the foreign aid stalemate on Capitol Hill. The attack has pushed the House to move Israel aid to the top of the priority list.
The House passed a stand-alone Israel aid bill last fall, but it never got considered in the Senate because the House bill paired aid to Israel with cuts to the IRS budget. Earlier this week, Speaker Johnson proposed a new approach: separate votes on each part of aid package―one for Ukraine, one for Israel, and one for Taiwan.
Whether the House and Senate can get on the same page on all this remains unclear. For many lawmakers, on both sides of the aisle, it's been a frustrating process. Ukraine aid has strong bipartisan support, but also loud voices of opposition on the right that have bogged down the effort. Aid for Israel also has strong support, but loud voices of opposition on both the right and the left. Aid for Taiwan and humanitarian assistance for civilian victims, they have much less opposition, but they've been caught in the middle.
My sense is that a resolution isn't too far off. So stay tuned.
Second, there was an interesting congressional hearing last week, which is not something I say very often. In a given week on Capitol Hill, there are dozens of hearings, held by committees and subcommittees to explore various issues and develop legislation―and most of them have a pretty narrow focus and don't make much news. Last week, the House Ways & Means Committee held a hearing that served as a preview of what will be one of the most important issues of 2025: taxes.
The issue is that all of the 2017 tax cuts, and that includes the lower individual income tax rates, the increased standard deduction, the lower corporate tax rate, and an increase in the amount of assets that can be inherited without triggering the estate tax, all of those expire at the end of 2025. It's a must-do item on the legislative list next year, and it offers a chance not only to address those particular issues, but potentially to rewrite other parts of the tax code as well. Last week's hearing previewed the two parties' distinct views on how to address the expiring tax cuts.
Republicans at the hearing argued for extending the tax cuts, saying that they helped boost economic growth and reduce poverty. Democrats argued that extending them would mostly benefit the wealthy and that the expiration deadline offered an opportunity to make sure the wealthiest filers pay their fair share. The chair of the committee, Republican Jason Smith of Missouri, said at the end of the session, "This is the beginning of what we're going to see over the next 20 months, with the expiration of $4.3 trillion worth of tax cuts on all Americans. So we have a lot of work before us."
That may be an understatement. This will be one of the most discussed policy issues in the run-up to the election, and it will dominate debate in Congress next year. It has huge implications for just about everyone, so we'll be keeping track of the rhetoric and the strategizing in the months ahead.
Finally, another brief update on the mess that is the SEC's controversial climate risk disclosure rule. The rule, which a divided SEC approved a month ago, requires public companies to disclose more to investors about their greenhouse gas emissions and the risks they face from climate change. It now faces 10 different court challenges, which have been consolidated into the Eighth Circuit Court of Appeals. Earlier this month, the SEC announced that it was pausing implementation of the rule entirely, pending the resolution of the various court challenges, a process that could take a year or more. Meanwhile, on Capitol Hill, legislation has been introduced that would repeal the rule, rendering the various court cases moot. It's unclear when or if a vote will be taken on that.
But this is all part of a theme that has become standard operating procedure in Washington, and one that I expect will continue next year and beyond, regardless of who wins this fall's elections. Regulatory agencies across all sectors of the economy are putting out rules that businesses or state attorneys general are quickly challenging in court. And regulators don't have a very good record in defending these rules against court challenges. I focus on the financial sector of course, and there are several recent examples of courts rejecting SEC rules.
The process of creating rules for an industry feels like it used to be more collaborative between regulators and the businesses they were regulating. Today, the process feels much more combative. There are lots of stories in Washington of regulators meeting with the business sector and not taking any notes or asking any questions, merely going through the motions of taking input. Last week, regulators abruptly canceled meetings with industry representatives about a proposed Department of Labor rule affecting investment advice in retirement accounts. That rule is expected to be finalized this week―and likely will be immediately challenged in court.
It's a busy time for regulatory agencies as they seek to wrap up rules before a potential change in which party controls the White House. Increasingly it seems the courts will ultimately determine whether those rules go into effect.
On my Deeper Dive today, I want to take a closer look at what's going on in the economy and the markets, and there's a lot going on. Another strong jobs report, combined with disappointing inflation data, may be changing the calculus for the Fed on rate cuts. Some members of last year's Magnificent Seven stocks aren't so magnificent. Geopolitical factors continue to reverberate in the markets. So to sort it all out, I'm pleased to welcome back to the podcast Kevin Gordon, senior investment strategist with the Schwab Center for Financial Research. Thanks for making the time to join me today, Kevin.
KEVIN GORDON: Hey, Mike, great to be back. Thanks for having me.
MIKE: Well, there's lots to talk about today, so let's get right to it. In the last couple of weeks, we've seen another very strong jobs report and a CPI inflation report that was a little bit disappointing, in that it, again, showed that inflation remained sticky, around 3.5%, still above the Fed's 2% target. I'm interested in how you see this data working together. Does the recent inflation data complicate the Fed's mission?
KEVIN: Last week was really this tale of two narratives, where you had the CPI, the Consumer Price Index, coming in hotter than expected, and then the PPI, which is the Producer Price Index, coming in cooler than expected. And the one data point that garnered the most hysteria, if you want to call it, was the Core CPI. So that increased by 0.4% month-over-month. And just to show you how obsessed we've become over each data point, the consensus estimate from Bloomberg, which is just a survey of economists on Wall Street that Bloomberg conducts for each data point, was for a 0.3% increase for CPI. So if you go out two decimal places for the reported CPI that we got, the increase was actually 0.36%. So of course that was rounded up to 0.4%. If the gain had been 0.34%, we would have actually rounded down to 0.3%, and it wouldn't have been counted as a miss.
Regardless, the near-term trend for Core CPI is accelerating. So it's a reversal from the trend that we had seen, which looked favorable at the end of 2023, but if you look at the index in terms of, you know, the three-month annualized percentage change, that trend moved up to 4.5% in March, which just means that these increases that we got in January and February turned out not to be blips. And just for some context, you know, when we talk about the three-month annualized change, we're really just taking the overall index. So the CPI itself, over the past three months, we're taking the change over that past three months, and then we're annualizing it to see what the gain would look like over a year's time.
And, you know, key to keep in mind with all of this is that Core CPI itself is not what the Fed is tracking. They're tracking PCE, which is the Personal Consumption Expenditures report. But the good news is that if you look at some of the components in the Producer Price Index that map actually a little bit more to what's going on in PCE, they actually suggest that we might not get as hot of a PCE report later this month.
And at the headline level, PPI has reaccelerated a bit, so it has been consistent with what you've seen in CPI. And if you look at the core measure, so the one that takes out the food and energy prices, we have seen sort of a move higher. So the three-month annualized change has gone up above 4%.
The good news is, is that once you start going down a few levels into the details, there are some encouraging signs that we won't see as hot of a PCE figure later this month. One of the examples is the auto insurance category. So insurance costs in the CPI version of auto insurance soared in March by 2.6% month-over-month, and that's a pretty strong gain relative to the past couple of years. Conversely, the same component in PPI only increased by 0.1%. So this is important because the one in PPI actually is the one that matters more and maps over to the auto insurance component in PCE. So if you were just looking at the CPI version of that insurance, there would be a lot of cause for concern. But if you were looking at what matters more to the Fed, and what they're watching, there isn't as much to worry about when it comes to this specific auto insurance angle.
And this is really kind of bringing us to the bigger picture of the differences between PCE and CPI, and we know that they're constructed differently. There's a ton of nuances to it. I mean, we could literally have a whole episode on just that. But this is going to matter a lot more if we continue to see these divergences in their trends. And it's interesting because for the so-called super core versions of both of these indexes which look at services, and they take out energy and take out housing, the trends have been moving in opposite directions lately. So if you look at the CPI Super Core Index, it's actually been moving higher in year-over-year terms, but the PCE version has actually been moving a little bit lower. And I don't think the Fed will just outright ignore the CPI version. But if we see a wider gap there with the PCE continuing to ease as the CPI continues to move higher, I actually wouldn't be too surprised if they feel comfortable eventually easing policy because they're focusing a little bit more on the PCE version.
MIKE: Yeah, Kevin, I think it's really interesting what you're saying about the tiny nuances inside these numbers, and how small the differences are, really, that grab really big headlines, depending on whether it's rounded up or rounded down. So I think that's really an interesting point.
Well, to stick with the Fed, the Fed raised interest rates in order to cool the economy. Rates, of course, have remained high. The economy continues to be hot. So what's going on here?
KEVIN: So this is one of the bigger misconceptions, I would say, in this cycle, particularly as it pertains to financial conditions and whether they've tightened, and thus, whether you've actually seen a cooling in the economy. So at a broad level, the economy has remained resilient as the Fed has tightened policy. But we have seen some of this rolling weakness over the past couple of years, first in manufacturing, then in housing, and then in goods. And that has started to spill a little bit into the services sector and to some extent the labor market, but so far that weakness hasn't really been enough to cause a broader slowdown in the economy. And much of that is due to the fact that services is both a larger part of the economy, and it's a larger employer. So if you don't have a meaningful slowdown in the services sector, it's kind of hard to see how a recession unfolds.
On the aspect of financial conditions, there are some really important nuances here that I think investors need to be aware of. And when you hear either from media headlines or analysts that financial conditions have eased a ton over the past several months, the chances are that they're referring to market-based financial conditions indexes. And these are mostly made up of indicators like the stock market, or bond yields, or credit spreads, or the dollar.
So just as an example, with the rally that we've seen in stocks since October and the tightening in credit spreads since that time, both of which are good things in and of themselves, financial conditions indexes have eased and actually loosened. But those are not necessarily the metrics that the Fed looks at to gauge whether actual financial conditions have eased. And you have to consider the fact that several indicators show that tight policy has actually had an impact on the economy. So you could look at things like bank-lending growth, which has slowed sharply, the growth in payrolls for cyclical industries like manufacturing, which has slowed to almost zero over the past year. You could look at banks' lending standards, which have tightened sharply, or you could look at consumer delinquency rates, which have been rising rather quickly.
So I mention this because there are many analysts and investors who suggest that just because stocks have rallied and credit spreads have tightened, that the Fed has to adjust policy in response to that. But the simple way of looking at this is the fact that the Fed is not targeting asset prices and probably cares a lot less about things like the stock market than conventional wisdom would suggest.
MIKE: Does the Fed have other tools that it can use against inflation?
KEVIN: So the primary tool is the change in the policy rate, but other than quantitative easing or tightening measures via the balance sheet, the Fed doesn't have additional tools. And, you know, one thing to keep in mind is that we might be entering a time in which monetary policy is just a bit less effective than it has been in the past. And I just mentioned many ways that the Fed has tightened conditions in this economy, but at the same time, there are segments of consumers and businesses that have been less affected by moves in interest rates this time.
So if you look at the consumer side, an example would be somebody who locked in a low long-term mortgage rate before the Fed started hiking rates. That person or family has virtually felt no pain on the housing side. For businesses, a similar picture. There are several that took advantage of refinancing their debt when rates were quite low in 2020 or 2021, and likewise, they haven't felt the sting of higher rates.
So if you look at the big picture, we kind of seem to be in this era that's dominated more by supply shocks, which are influencing the inflation backdrop more. And just looking at the past four years, we've seen considerable shocks. You've had the pandemic. You've had two major global conflicts. You've had a shipping and a supply crisis with China. And then a massive shortage in domestic foreign labor. And as you and I have discussed, it's one of Liz Ann's and my calls that we might be entering this period of more supply shocks. We think this is kind of a secular shift. And when you have more of those shocks, as opposed to demand shocks, it's harder for central banks to respond and expect policy to have more of a direct linkage to inflation.
And you can use the labor market almost as an example. So I'll just give you a quick one right now. If you think back to a few years ago when we had seen this huge drop in the labor force due to the pandemic, it's kind of tough to imagine how either lowering or raising interest rates would actually change that picture. So just a question to ask yourself. How is a worker going to be inspired to join the workforce based on what the fed funds rate is? So I would look more to what was happening in other areas and the other forces that were at play in the labor market. So we've seen a major improvement in labor supply over the past couple of years, but really only for the prime age workforce, so the people that are aged 25 to 54. And a huge driver of that has been immigration. The growth in the domestic foreign labor force in the U.S. has been quite weak. And, actually, it's been non-existent if you're measuring growth back to the beginning of 2020.
That right there is an example of how Fed policy can't really be tied to a key supply shock that we've faced, at least in this country, over the past couple of years. And it's not that the Fed policy doesn't matter or won't matter; it's just that its impact on the economy might look different in the coming years.
MIKE: Kevin, it's amazing to me how much coverage there is every single day of what the Fed is doing, thinking, saying. Fed governors are out all the time speaking to different groups and providing their opinions, all of which seem roughly the same. They're all coordinating their message. And the amount of attention that's paid to it in the media, and the actual connection, I think, to ordinary people, sometimes, is pretty hard for people to understand.
One other aspect that I'm interested in is the seemingly unstoppable increase in the federal debt. High interest rates mean that the government is spending more to service the nation's debt. And, in fact, last year, the cost of servicing the debt surpassed defense spending to be the largest expenditure of the federal government outside of Social Security and Medicare. So is that a factor in keeping inflation sticky?
KEVIN: So as a macro issue, the debt is definitely something I think is concerning. But I am also realistic in recognizing that, number one, there doesn't seem to be any indication that Washington wants to do anything about it, and number two, it's hard to tie the growth in debt or deficits to the moves in interest rates.
So to expand on that first point regarding Washington, you know, I'm not exactly sure when the turning point was however many years ago, but it seems like there's just bipartisan support these days for "who cares" when it comes to the debt and deficits. And you're right to point out that our spending on interest costs will start to outpace things like defense spending, but I haven't seen any members of Congress come up with a plan to reduce that or even discuss why it's become a major issue.
And for the second point, while I do have sympathy with concerns about kind of the tie in with interest rates, we also have to consider the objective data. So courtesy of the work done by our chief fixed income strategist and our colleague Kathy Jones, it's actually hard to find a relationship between the actual growth in the federal debt or the deficit each year and the direction of interest rates. And there are many investors who are very concerned, rightfully so, about high debt or deficit spending leading to inflation, but the historical data just don't really support that thinking. And in fact, there's really no statistically significant relationship between growth in debt or deficits and the moves in interest rates.
And just to give a sort of real-time example on this, if you go back to July of 2022, and you look at the year after, so up until July of '23, we had seen quite a significant increase in the deficit as a percentage of GDP. So if you look at that share, it went from 3.7% to 8.3%. That's a huge jump relative to history. But over that timeframe, the year-over-year change in the CPI actually eased from 8.5% to 3.2%. And not only that, but if you look at the change in the deficit share of GDP since July of 2023, it's actually gone from 8.3% to 5.9% today. So it's eased. But over that same timeframe, the year-over-year change in CPI has moved up a little bit, from 3.2% to 3.5%. So if anything, those two examples are basically a mirror image of each other. They paint the opposite picture of how people tend to think when it comes to deficits and inflation.
And just speaking broadly, or broader, on the direction of inflation, that's really what's going to determine the Fed's policy moving forward. I think we have to remember that the Fed's mandates are stable prices and full employment. So the debt and deficits are not going to drive their decision-making when it comes to monetary policy.
MIKE: Yeah, great point about the federal debt, and I certainly agree with you that Washington doesn't seem very excited these days about addressing it. You've heard me say this before, and we've talked about this, Kevin, but one of the reasons, I think, for that is the debt has become such an absurd number, $34-plus trillion, that it's kind of meaningless to the ordinary person. I don't think the ordinary person has much ability to understand why that affects them. And therefore, they don't really protest or urge Congress to do anything about it. So I think you're right that we've gotten to this kind of cover our eyes and just keep watching that number go up here in Washington.
Well, I want to shift to the markets. One of the narratives is that a key driver of the strong start to 2024 has been the market pricing in a series of rate cuts. But the market's expectations for rate cuts in 2024 keeps moving down, fewer cuts and a later start date for the cuts. A lot of analysts now speculate in that there may not be any rate cuts at all this year. So will few or possibly no rate cuts mean that the markets will retreat?
KEVIN: So I'm not as much in the camp that the market's rally this year has purely been propelled by the pricing in of cuts. And if you use the S&P 500 as a proxy for the market, we've seen a gain of about 7% this year. We've had some kind of weakness over the past couple of days, leading up to the time that we're having this discussion. But that gain has happened even as the fed funds futures market has gone from pricing in nearly seven rate cuts this year, and this was back in January, to just two. So I have two points to make with this.
The first one is that given the market has managed to move higher even as those cuts have been priced out, does that mean that the cuts were ever even there in the first place and boosting stocks? I'm not so sure. The fact that you've had five cuts being priced out without a major correction in the market proves that perhaps the cuts themselves were not that important.
The second point is that we have had a lot of corrective activity in the market this year. It's just sort of happened in a stealthy way. And if you look at each member's maximum drawdown this year across the major indexes, and you take an average, you'd get to down 10%, on average, for the S&P 500, down 29% for the NASDAQ, and down 22% for the Russell 2000. So for the latter two, you're already in bear market territory.
It's a pretty good way to go through a correction or a bear market, but it also dispels the notion that everything has just been smooth sailing for stocks, at least in the United States, this year. And fortunately, the corrective activity hasn't yet bubbled up to the surface of the indexes. But given the churn that we've seen, it wouldn't be a surprise to me to see a little bit of a broader pullback.
MIKE: Another aspect of the markets that I know you get asked about—even I get asked about it in my talks—and that is the so-called Magnificent Seven. The market was dominated last year by these seven stocks, which, together, rose by about 70%, while the other 493 stocks in the S&P 500 rose by about 6%. This year, of course, a very different story. Maybe we're down to, I don't know, a Fab Four or something. But what do you see happening with these mega-cap stocks? And it seems like the broadening of the rally, that's a good thing for investors, right?
KEVIN: Yeah, so this Magnificent Seven or MAG-7, as I call it, narrative has had, actually, several holes that have been poked in it over the past year. And it didn't even end up being that strong of a narrative by the end of 2023, because you had Apple, which was the largest company at the time in terms of market cap, Apple had finished in 63rd place in the S&P 500 last year. This year, its ranking is much worse. And if you go beyond that, Tesla has spent the majority of this year in last place in the S&P. And that's a remarkable shift just for that stock, you know, when you compare it to 2023, because back then, in that year, the stock actually finished in 10th place by the end of the year.
So we've seen almost this maximum dispersion in the MAG-7 itself, where you've got a couple of members that are sometimes in first place, leading the rest of the market in terms of performance, and at times other members that are in dead last. And as that's happened, other parts of the market have actually done quite well. So just this year, sectors like financials and energy have actually pulled ahead. And, in fact, their underlying breadth has actually looked much healthier when you compare them to sectors like tech and communication services, which were the dominant ones last year.
So if you look at the number of stocks, just as an example, that are making new highs in each sector, there has been considerable strength in areas like energy. And conversely, if you look at the number of new highs in a sector like tech, that's actually been easing and cooling considerably over the past couple of months. It doesn't necessarily mean anything sinister for that sector, but it does reinforce the fact that tech is not the only game in town when it comes to sector outperformance.
There are several companies that screen well across a wide variety of quality metrics, things like high interest coverage, or strong profitability, or high free cash flow, and they can be found in sectors outside of tech. So it does support and reinforce this idea that a broader rally can continue to hold. It doesn't discount the fact that things have gotten a little frothy from an investor sentiment perspective. But for the long-term health of the bull market, broader participation has tended to bode well for stocks.
MIKE: Let me pick up on sentiment for a minute. How is investor sentiment holding up amid all of the uncertainty out there? You and I both have been on the road talking to investors a lot over the last couple of months. It seems like there are so many anxiety points out there. The looming election is one I hear a lot about. The ongoing wars in Ukraine and Israel. Tensions with China. Rising oil prices. Uncertainty about what the Fed will do and when. Challenges in the supply chain, particularly when it comes to shipping through some of the various hot spots around the world. So there's a lot to worry about. Do the sentiment surveys match what you're hearing from investors?
KEVIN: So yes, I have heard those anxieties, many of them that you've listed. I'm not sure that they would necessarily translate or have necessarily translated into some of the weaker sentiment data that we track because we look at a variety of attitudinal and behavioral metrics. And if you aggregate those, we're kind of still hovering in what I think of as this excessive optimism territory. And just as a reminder, when I say attitudinal, those are metrics that really track how investors feel and what they're saying. So if you think about something like this weekly survey that we look at, which comes from the American Association of Individual Investors, we just shorten it and call it AAII, it asks a series of questions, one of which is how investors feel about the market. So the organization will just record the percentage that respond in bullish, bearish, or neutral terms, but that really doesn't capture anything about their positioning or what they're doing with their money. So if you think about getting a call from AAII on a day when stocks are soaring and doing really well, you might be kind of hard pressed to say that you feel bearish. And conversely, if you got a call on the day when the market is sinking, you probably won't answer with as much of an optimistic tone.
So because of that alone, I like to focus, personally, more on the behavioral side, things like investor positioning and fund flows. And these are the metrics that really tell us what investors are actually doing with their money. So they might say that they're not feeling good about the stock market, but that is irrelevant to me if they're continuing to put money into stocks or into equity funds. And as of now, we're still seeing a relatively elevated level of optimism. And one of the ways we look at this is via the Crowd Sentiment Poll that comes from our friends at Ned Davis Research. And they built this gauge, which is an amalgamation of attitudinal and behavioral metrics, and it kind of gives you a bigger picture and a broader picture as to where sentiment is in aggregate terms. And it has been in extreme optimism territory since late November 2023.
The only rub with that is it doesn't really tell us much about the near-term direction for stocks as it does about the fact that they're vulnerable to a pullback. So you could go back, and you could look at prior periods when we've gotten to this level of optimism, and we have tended to see pullbacks ensue, but there's no timing associated with it. So it's not as if you get to extreme optimism and then you can start counting down on the clock and say, "OK, we can expect a pullback X number of days, or weeks, or months later."
So that's really the point with sentiment—is it's to help us understand that we are in more of a vulnerable state. And in the event of a negative catalyst, you could see stocks tip over more. But you do need to see that negative catalyst actually come into fruition. We would argue maybe that's some sort of hotter inflation data or a move higher in yields, but that sort of remains to be seen right now.
MIKE: Well, Kevin, this has been a great discussion. I want to end here. There's an old adage that investors should sell in May and go away, because so often the latter part of the year is not as strong as the first part. So first, do you adhere to that line of thinking? And I'm going to go out on a limb and guess that maybe you don't. But second, and more importantly, how should we be thinking about where to trim and where to look for opportunities?
KEVIN: So you are correct. I don't adhere to that. And, you know, I'm not a big fan of seasonals when it comes to determining the direction of the market and definitely not when it comes to how investors should approach the market. I think there should always be caution associated with those adages, especially like "Sell in May and go away," because they often come off as these concrete rules, and it's really hardly the case. So as you mentioned that adage suggests that investors should sell at the beginning of May and not return until the end of October. So it's really just saying that the market doesn't perform well in that six-month period.
And if you put some numbers on that, and you really just look at the past four years, I'll give you some performance data on that. So in 2023, that May through October, the S&P 500 was up by 0.6%. In 2022, it was down by 6.3%. In 2021, it was up by 10.1%. In 2020, was up by 12.3%. So there's just one year out of four in which there was weakness in that six-month period.
But even in 2022, the bear market started in January of that year, so there wasn't really anything prescient about selling in May. If you want to be really technical about it, you actually would have missed the right selling point in the market, which was the beginning of January. But that's not how anyone should have approached investing in that year or really in any year. And as you alluded to, we think investors can benefit a lot in this environment, not from adhering to adages like that, but from taking something that we call more of a volatility-based approach to rebalancing. We talk about this a lot, but this has proven to be a relatively prudent strategy over the past couple of years. And it really centers on the part of an investor's portfolio, or parts of a portfolio, that are either really stretched above allocation or way under target. And just to give an example or an illustration, if you look at the past year, sectors like tech have done exceptionally well, and those like energy have actually lagged behind. So it might make sense if you're just looking at those two sectors, and, again, just as an illustration, to trim the former, so trim some tech, and then add to the latter, add to energy. That actually would have been a relatively good move, since we've seen tech cool off a bit over the past couple of months, and then energy stocks doing quite well.
So it depends on the individual investor's target allocation. It depends on their goals for income. It depends on their tax considerations. But we really just want to reinforce this idea that volatility-based rebalancing can be a good thing, especially since calendar-based rebalancing tends to be a little bit more popular and a little bit more well known.
MIKE: Well, great perspective, as usual, Kevin. Really enjoyed having this discussion and really appreciate your time talking to me today.
KEVIN: Thanks so much, Mike. It's always great to be with you.
MIKE: That's Kevin Gordon, senior investment strategist at the Schwab Center for Financial Research. Kevin recently joined X, formerly known as Twitter, so give him a follow. You can find him @KevRGordon.
That's all for this week's episode of WashingtonWise. We'll be back with a new episode in two weeks, featuring Schwab's Chief Global Investment Strategist Jeff Kleintop and a discussion of the seemingly ever-expanding geopolitical developments and their impact on your portfolio. Take a moment now to follow the show in your listening app so you don't miss an episode. And if you like what you've heard, leave us a rating or a review—those really help new listeners discover the show.
For important disclosures, see the show notes or schwab.com/WashingtonWise, where you can also find a transcript.
I'm Mike Townsend, and this has been WashingtonWise, a podcast for investors. Wherever you are, stay safe, stay healthy, and keep investing wisely.
