There is no sugarcoating the stock or bond markets in the first half of 2022. It has been a very difficult environment for investors and very few places have offered any relief from selling pressure. The primary cause of the decline has been inflation. Persistently high inflation, with levels not seen since the 1980s, are creating concern about the current and future trends for businesses and consumers. Further, the tools commonly used to control inflation have the unfortunate side effect of slowing economic growth, leading to a potential recession as monetary policymakers act aggressively to curb rising prices. With that said, there are reasons for optimism in the future, and while things may look bleak now, history tells us that recoveries can often come sooner and with greater force than we anticipate.
Economic trends have been a mixed bag, with recent data reflecting a slowing US economy and potentially recessionary conditions. On June 30, the Federal Reserve Bank of Atlanta released their Q2 forecast of US Gross Domestic Product (GDP) that is now negative 1%.1 If this estimate proves correct, it will be the second consecutive quarter of decline in gross domestic product. This is the definition of a recession. While the prospects of a recession are rising, the much more prevalent fear is high inflation will remain with us for the foreseeable future. Gas prices increased to record highs in mid-June and are up by over 50% over the past year while food prices have also climbed by 10%.2,3 Homebuyers are facing a near 20% increase in home prices and with mortgage rates that have nearly doubled since last June.4,5 The saving grace of the economy thus far has been a healthy job market, with a very low unemployment rate of 3.6% and wages rising over 5% in the past year.6
In the stock market, the S&P 500 is in a bear market (down over 20% year to date) and has experienced the worst first-half start since 1970. The Nasdaq, which has more exposure to growth sectors like information technology and biotech, declined over 22% in the second quarter and is down 29% year to date.7 Despite the significant decline in the markets, estimates of corporate earnings growth have remained relatively steady.8 Skeptics will point to earnings as the “last shoe to fall”, but if companies continue to show an ability to grow, stocks are now significantly cheaper than they were at the beginning of the year.
When the stock market has periods of corrections, investors have typically looked to bonds as a source of relief from volatile stock price declines. This year that has not been the case. Bonds have an inverse relationship with interest rates – when rates go up, bond prices go down. So, as a result of persistently high inflation, the US Federal Reserve has raised the fed funds rate higher, pushing both short- and long-term US treasury rates dramatically higher this year. As a result, US treasuries, often used as a primary source of protection in client portfolios, are down 11% this year. If the year ended today, that would be the worst performance on record since the data was tracked dating back to 1973.9
As shown, it isn’t hard to find data that creates a negative picture of the economy and a dour outlook for stocks and bonds. However, history would tell us that markets often reward patient and prudent investors who stay the course even during difficult times. Bear markets tend to be swift and painful while bull markets are slower but last significantly longer. Of the 14 bear markets since 1945, the average decline was 32% but the time to recover losses was slightly less than 2 years.10 Further, since 1950, the average return for the 12 months after the initial entry into a bear market is 15%, which is higher than the long-term average return of the S&P 500.11. Lastly, this is a midterm election year, and historically performance of the S&P 500 leading up to midterm elections have been below average, but the 12 months afterward have been significantly higher than long-term averages.12
To get a different perspective on our current situation:
- Stocks are less expensive than the beginning of the year and current valuations are below the five- and ten-year averages8
- Income from bonds, which has been extremely low since 2020, currently pays investors over 3% to hold 10-year US Treasury bonds and 4.85% for investment-grade corporate bonds13
Simply put, while we may not be at the absolute bottom of the market declines, achieving your financial objectives doesn’t require investors to be exact about timing market tops and bottoms. In fact, attempting to time the markets often leads to reduced returns as investors tend to act emotionally, sell low, and miss out on substantial future rallies. The average S&P 500 return from 1926 to 2021 was 10.34%, but to achieve these returns, investors have to be willing to accept risk and the potential for significant declines.14 The best and most consistent way to achieve your financial goals is with a sound financial plan that incorporates safe assets for markets like our current situation combined with growth assets that benefit from the eventual rebound that history has repeated time and again.