Here’s all you need to know. (If you’re in a rush.)
The Q2 numbers¹:
- US Stocks -16.85%
- International Large Cap Stocks -14.90%
- Emerging Markets Stocks -11.59%
- US Bonds -4.50%
- Energy sector stocks -5.96%
- Technology sector stocks -22.33%
- Losses accelerated for most major asset classes, led mainly by high growth tech stocks in the US.
- Inflation continued to heat up, although signs of a peak are beginning to show up in the latest data.
- To combat inflation, the Federal Reserve changed course and began raising interest rates more aggressively than they had anticipated earlier in the year. The stock market doesn’t like surprises.
- At the midpoint of 2022, US stocks just finished their worst first half of any calendar year since 1970, and bonds experienced their worst first half ever. While this may be an alarming headline, a little perspective can help long-term investors find an important silver lining.
And now for the long(er) version…
Globally, inflation continued to be the hot topic on the minds of investors and consumers in the second quarter of 2022. Many economists at the Federal Reserve and other central banks around the world had hoped consumer prices for essentials like gasoline and food would peak and begin to decline early in the second quarter. Unfortunately, inflation continued to spiral higher thanks in large part to the continued war between Russia and Ukraine, China’s “zero COVID” policy/lockdowns, and a very hot summer travel season in North America and Europe.
As discussed previously, central banks like the US Federal Reserve, have a limited tool chest when it comes to fixing the inflation problem. Their most powerful and effective tool is the ability to influence interest rates throughout the economy. Raising interest rates is the most direct way the Fed can slow the economy, thereby bringing down inflation. In fact, slowing the economy quickly by sparking a recession has historically been one of the most effective ways to tame the inflation beast, even if the Fed would never state a recession as their goal.
While recession may not be the goal, it is the increasingly likely (and somewhat necessary) risk to take at this point, in the eyes of most experts. However, any coming recession could be one of the strangest we’ve ever experienced, given that most economic indicators continue to show one of the strongest labor markets in history, rising wages, and consumers continuing to spend heavily on discretionary items and services, despite surveys showing a growing lack of confidence. Those are generally not signs of being anywhere close to a recession, at least in the traditional definition – two or more quarters of negative GDP (Gross Domestic Product) growth.
No two recessions are alike
The term “recession” often brings about memories of major market events for investors, like the Dot-com crash of 2000-2001, the Great Financial Crisis in 2008-2009, or more recently, the COVID crash of spring 2020. However, there have been many recessions in our history that have been short lived and relatively minor events. Given our most recent data, a minor recession tends to be the most likely outcome over the next six to twelve months, at least for the moment.
As we often remind our clients, markets are forward-looking, while economic data is trailing. This means that markets have essentially been on the decline all year so far, due in large part to the expectation of a recession we technically are not yet in. Because of this forward-looking mechanism, markets often begin recovering from bear market declines (pullbacks of 20% or more from recent highs), long before we even know we are in (or WERE in) a recession. This is the silver lining for investors at the moment.
Markets are forward-looking
Consider for a moment just how many times US stocks have seen bad quarters like we just had in Q2. Following these major declines, stocks have historically performed VERY well, highlighting once again the importance of not reacting and changing your long-term strategy in times like these. Below are the 20 worst quarterly declines we’ve experienced, going back to 1926:
As you can see, the average return for stocks one year after a quarterly decline like we just experienced in Q2, has historically been 18.6%. And looking out ten years later, the market has historically more than doubled. When you have time on your side, it’s easier to start to view these pullbacks as the opportunities they have always been, especially for investors with decades to go.
The worst first half since 1970
Now, the headline catching everyone’s attention the last couple of weeks is the fact that we just closed out the worst first half of any year for US stocks, since 1970. Not to mention the worst first half for US Treasury bonds, since 1788², when the US Constitution was ratified. But here’s the thing – there really is nothing particularly important about the first six months of any calendar year. It’s just an easy and consistent start and end point we anchor to. In reality, stocks have had many other six month periods worse than what we just had. They just didn’t happen to start in January and end on June 30th. In fact, there have been 13 other six month periods since 1957, where US stocks have declined more than 20%, meaning it happens about every five years. And if we look specifically at 1970, the last time the very specific Jan-June period was this bad, we see that the market rebounded and actually ended the year higher than it started³.
The honest truth is no one knows what lies ahead. And trying to predict the future of markets is a dangerous habit for investors to get wrapped up in, despite how hard it is to stomach a lower account balance for the time being. We know that these tend to be the moments investors begin to doubt their strategy and wonder if markets will EVER recover.
We also know that the doubt many investors feel right now often leads to making changes, like becoming very conservative or selling all stocks and sitting in cash. History has a very strong track record indicating just how detrimental those decisions can be. So, we’ll remind you as we often do, that there is still no market decline in history, of any amount, that did not end in a full recovery. And the recovery often happens far more quickly than someone attempting to time the market would like. It’s not a winnable game to play with your money.
Can down markets be…good?
We often get questions from clients about what changes we are planning to make to address declining balances. Our answer can be frustrating, given that we don’t tend to react to market swings like this. It’s not beneficial to do so in our mind. Instead, blooom is here to help coach our clients on the importance of maintaining discipline with their strategy and a long-term focus.
It may not feel like it in real time, but broadly declining prices are a good thing for long-term investors. And while we all want this bear market to end, younger stock investors in particular stand to actually benefit from a longer, drawn-out period of down or flat market returns. This is because anyone making regular contributions to their investment accounts like a 401k or IRA, is still in an accumulation phase when it comes to their wealth. And when you’re contributing regularly to accumulate for a long-term goal, the lower the prices you are buying at, the better off you will be when markets eventually recover. That said, the stock market tends to be one of the only places where people hate to shop during a big sale.
The case for (still) holding bonds
Now, for those closer to retirement, the decline in bonds likely has you just as concerned (if not more) than what’s happening with the stock market at the moment. Bonds are generally held in a portfolio to balance risk and hedge against stock market volatility. So far this year, that hasn’t worked well, due primarily to rapidly rising interest rates. However, the good news is that you likely are not holding individual bonds in your retirement accounts. Here’s why that is good…
Bond mutual funds, index funds, and ETFs, are broadly diversified portfolios of hundreds or even thousands of individual bonds. These bonds vary in type and time until maturity. This also means the interest rates of each individual bond vary widely. With bonds regularly maturing in these portfolios, proceeds are used to purchase new bonds at today’s market rates. This process helps mitigate the long-term impacts of rising rates for the investor. This is very different from someone owning an individual bond when rates are rising, which carries significantly higher interest-rate risk.
While some short-term pain is usually a reality for bond investors when rates are rising, the construction of a broadly diversified bond index fund (which blooom seeks and recommends to clients where available), means that the portfolio will gradually reset and adapt to the new market environment somewhat automatically, by purchasing and holding new bonds at new market rates. This is actually a very good thing in the long-run for bond investors, especially those closer to retirement, who will benefit from higher interest payments from the bonds held in the fund’s portfolio.
The bottom line is…
No matter where you are in your journey to retirement, an investment strategy tailored to your specific timeline and risk tolerance is an essential part of surviving (and actually benefiting from) years like 2022 (so far). The key is to let the plan work, by sticking to it even when it feels the hardest to do so. Good things tend to come to patient, disciplined investors, but confidence and understanding of your strategy is a must-have.
If you find yourself questioning the strategy we’ve implemented or are recommending for you and need some help diving deeper, please don’t hesitate to contact our team. We have advisors ready to help keep you on course and even find a more appropriate long-term approach for you, if that is what will help you keep that long-term focus going forward.
The information is provided for discussion purposes only and should not be considered as advice for your investments. Past performance is no guarantee of future results. Please consult an investment advisor before you invest.
Published on July 27, 2022