2022 has been a far cry from the positive and mostly smooth market of recent years. A sudden negative shift in January has accelerated downward as the year has progressed. The S&P 500 has officially entered a “bear market,” which means it crossed the -20% threshold from its January high. It’s worth noting that several other benchmarks, notably the NASDAQ and Russell 2000 passed the -20% threshold weeks ago. There are many factors that have led to the market’s poor performance, namely inflation, the Federal Reserve raising interest rates, ongoing COVID disruptions, and Russia’s invasion of Ukraine have all combined to create a treacherous environment for investors.
As of this writing, the most impactful issue affecting investors appears to be a “pivot” by the Federal Reserve from an accommodative monetary policy to a more restrictive tightening policy. Their strategy shift has been in response to an alarmingly swift rise in inflation over the past year. There have been several contributors to the current inflationary pressures. The economy has been heating up coming out of the worst of the COVID crisis. Supply chains have been disrupted due to COVID and have struggled to meet increasing demand. Record amounts of government stimulus have created more liquidity. And the Russian invasion of Ukraine has pushed energy prices higher.
In response to mounting inflation, the Fed is responding with the primary tools at their disposal. They are raising interest rates and reigning in their accommodative monetary policies in an attempt to cool off the economy. They’ve stated that they plan to raise short-term rates from 0% to 2.5% over the coming year. They initiated their plan earlier this year and have increased rates 0.75% thus far. The market, as a forward-looking mechanism, raced immediately to price in all of the coming rate hikes. This pushed bond yields higher (and bond prices lower) and has punished the stock market. The downward pressure has been especially acute in the most speculative areas of the market, namely technology stocks, small cap stocks, and cryptocurrencies. While some areas have suffered more than others, most every type of investment has moved lower, leaving few places for investors to find safety.
One of the more difficult aspects of the market this year has been the negative performance of the bond market. In short order, bond yields jumped in response to the Fed’s intention to raise interest rates. The result is that the bond market suffered one of the worst performances in its history. Unlike most stock market pullbacks, this time investors with diversified portfolios didn’t enjoy the positive movement in bond prices that normally offsets losses in the stock market. The silver lining is that bonds now offer much higher yields, promising better income going forward. We’ve made a point to touch base with several of our bond managers in recent weeks and have also heard from several market strategists. They all agree that the worst of the negative performance in the bond market has likely passed, and that bonds are a lot more attractive now than they were at the beginning of the year.
If the Fed’s goal has been to cool the economy, it appears that the market is doing a lot of the work for them. The threat of higher interest rates in the future has already caused rates to move much higher. Lending rates have jumped, cooling purchasing activity for high ticket items, such as homes. Consumer sentiment has shifted to a decidedly negative pitch. All of this negativity has begun to slow activity in many of the overheated parts of the economy. So much so, there is a growing fear that the economy may soon enter a recession.
Times like this highlight why diversification is so important. Investors who take big positions in individual stocks or focus only on particular strategies run the risk of big losses from which their portfolios may not soon recover. Some of the best performing stocks and strategies in 2020 and 2021 have been among the hardest hit. The FAANG stocks, for instance, are down more than 30% this year. The much-heralded ARK Innovation Fund, which invests in technology high-fliers, is down more than 50% this year. Unlike investors who chase the hottest investments, investors with well diversified portfolios can feel confident that when the broader market recovers, their portfolios will recover as well.
Taking a step back, we’d like to point out that the stock market has enjoyed an exceptionally good run in recent years. Even with the COVID panic in the spring of 2020, the last three calendar years have delivered an average annual return for the S&P 500 of 26%. This is well above the long-term average of 11.5%. The (almost) 2-year period ending in December of 2021 saw exceptionally low volatility as well. Considering the uncharacteristically calm environment and robust gains, a pullback at this point is not surprising. But like all market pullbacks, it was impossible to predict when it would begin or when it will end. It has been said that “the Market Timers Hall of Fame is an empty room.” More positively, we feel confident that this pullback will eventually end and that the market will recover and reach new highs. Whether that happens later this year, next year, or the year after, it is not possible to predict that either. For investors with a long-term time horizon, this year’s market decline shouldn’t change much about the long-term success of their financial plans.
Thank you very much for your continued confidence in our service and advice. If you would like to discuss our opinions, outlook, or your portfolio in greater detail, we would be happy to schedule a meeting or a conference call at your convenience. Lastly, don’t keep us a secret. If you know someone who would like help planning for their financial future, we will be pleased to speak with them to see if we can assist.
Horizon Wealth Advisors is a Houston based fee-only wealth management firm. Horizon is a fiduciary advisor. We specialize in helping successful individuals and families understand, organize, and manage their often complex financial situations. Horizon offers integrated financial planning and investment management services.