If you follow the news headlines then it probably comes as no surprise that the included chart is filled with an unfortunate amount of negative/red numbers. The S&P 500 finished the first half of the year down nearly 21%, which is the largest first-half loss we’ve had in more than 50 years. Ironically, the historical safe haven to stocks, bonds, are also down double-digit percent in the first half of the year, seemingly leaving investors no place to hide. This scenario of declines in stocks and intermediate-term bonds in back-to-back quarters is very rare, only happening twice prior (1969 and 1974). Depending on the instrument, even the supposed inflation and market hedge, gold, was flat to slightly negative in the first half of the year.
Our Perception of Key Market Forces
You might be wondering what the key contributors to the rout in investment markets are. While there are many headwinds, we believe the largest drivers to negative returns continue to be inflation, Federal Reserve policy (rate hikes), the continued Russia/Ukraine war, and ongoing supply chain issues due to the Covid-19 disruptions.
Regarding Federal Reserve policy, the central bank is attempting a delicate balancing act of trying to help inflation roll over, but not so aggressively that they catapult the economy into a recession. The optimism around effectively achieving a “soft landing” is fading. In my opinion, it will be rather difficult to fight off a recession. One of many data points suggesting that is the Atlanta Fed’s GDP projections having declined from 1.9% to -1% over the last two months. On the other hand, some attributes that the Fed is hoping might help bypass a recession are a strong labor market with a high level of new job openings, as well as their stated stance to be nimble and data dependent.
Let’s discuss the proverbial good news and bad news, starting with the latter so that we can end with some encouragement.
The Bad News
All of the usual contributors to a recession are present today, some of which are rising inflation, declining consumer sentiment, tightening Fed policy, a stronger US dollar, and a flattening of the yield curve. We are also in a confirmed bear market, which is a decline in the market index of 20% from the highs. Historically, bear markets last about a year and take about 11 months to reach the “bottom.” If you’re reading between the lines, this means we could (and are likely to) fall further.
The Good News
It’s not a given that stocks will continue to decline if we end up in a recession. The S&P 500 has actually been positive in four of the last nine recessions. When declining, the average decline is just 1.5%. But what about the bear market? If we reach the average bear market decline of being down 33%, it would require a gain of 50% to get back to even. Once we are in bear market territory it takes about 25 months to break even on average. That means we could see strong double-digit returns on the way up, which is why perseverance is key.
The news headlines would lead you to believe this time is different, which the actual headlines are, but the cycle is no different than previous cycles. Since 1950, the S&P 500 has made it through 32 drops of 10% or more, 13 recessions, and many wars. On average, since 1980 the S&P 500 experiences a decline of 14% every year, and returns have been positive in 32 of those 42 years. (You might want to re-read that sentence and let it sink in.)
Behavioral Finance Bias Warning
Losing money isn’t my idea of fun, and I’d imagine you would agree. This reminds me of a common behavioral finance bias. Loss aversion bias is an emotional bias that says, “The pain of losing money is psychologically twice as powerful as the pleasure of making the same amount of money.” After experiencing the longest bull market in history and working with many clients, I see that this bias is alive and well. How can we combat rash decisions that it might cause us to make?
It’s important to remain disciplined in your investment strategy and financial plan. If six months is going to make or break your plan, then I would argue that it wasn’t an appropriate plan to begin with. If you’ve been investing for a long time, you know the market has been in a rut before and will be in one again in the future. If you’re new to investing, this is a timely initiation. Markets don’t go up every year like clockwork, and you don’t want to hang your hat on predicting which years they will go up. However, for veterans and rookies alike, there’s plenty to do during this period that can enhance your long-term investing success. This includes tax loss harvesting, rebalancing allocations, revisiting risk tolerance, value hunting, and dollar cost averaging with cash or payroll contributions.
The famous economist Paul Samuelson said, “Investing should be more like watching paint dry or watching grass grow.” While that is hard to do in today’s world of 24/7 news and predispositions of immediate gratification, it has worked in the past. I believe it will continue to work in the future. Having a long-term outlook can provide peace of mind and less heartburn in periods like we are experiencing today.
We are thankful for the trust you place in our team and the partnership that we have. As always, please feel free to reach out to us with any questions or concerns you may have regarding your specific situation. We are happy to help and enjoy the opportunity to do so.