If you feel exhausted and disgusted by the stock market this year, above is a visual representation of the up and down nature of the S&P 500 for 2022 through September. The fact that the downturns far exceeded the upturns is of most concern. Here is a summary of the returns losses for major indexes for the three quarters of 2022 ending in September:
S&P 500 | -23.87% |
Aggregate Bond Index | -14.61% |
EAFE (international) | -27.09% |
Nasdaq | -32.40% |
Below is a small sample of the economic carnage that accompanies the dismal investment environment:
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- Consumer confidence is near historic lows [FRED]
- Mortgage rates are the highest since 2008 [Mortgage Bankers Assoc of America]
- Manufacturing and Services indexes are weakening [Institute of Supply Management]
- The Recession Alert newsletter predicts a high probability of a recession in the next 12 months
Why are the stock market, bond market, and economy all tanking? Two words – Inflation and the Fed. Inflation is like a cancer that destroys our purchasing power and affects everyone’s daily lives. The Fed initially ignored rising inflation and did nothing for almost a year. (Remember “transitory”?) Once they figured out they had been wrong, they decided to wear their newfound religion on their sleeve. Jerome Powell, the Fed Chairman, promised to beat inflation by wrecking the economy (my words, not his). Here are his ominous words at the Jackson Hole Conference held this August:
“Reducing inflation is likely to require a sustained period of below-trend growth. Moreover, there will very likely be some softening of labor market conditions. While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses. These are the unfortunate costs of reducing inflation.”
Jerome Powell
The markets quickly deciphered Powell’s “fedspeak”. “Sustained period of below-trend growth” means Recession, and maybe a bad one. “Softening of labor market conditions” means Unemployment. “Pain to households and businesses” means Sell Everything Now!
There is an old saying – “don’t fight the Fed”. It seems to me we should take their words at face value and prepare for a recession and pain to our financial assets. We have taken several steps in client portfolios to limit downside risk, protect principal, and maximize income while still maintaining upside potential as follows:
- Shifted a significant percentage of equity assets to more tactical investments. (See our website for the blog titled “Time to get Tactical” for an in depth discussion.)
- Sold underperforming funds and trimmed several other funds to raise cash.
- Shifted significant portions of bond funds to a ladder of US Treasuries (one, two and three year bonds).
- Put a majority of remaining cash in a treasury backed money market account that is currently paying more than 2.5% annual interest.
Fair Questions
I get asked a myriad of questions daily about the economy and the markets. I also pose many questions to members of my team and search for answers. I thought I could ask and (try to) answer some questions in this blog that might be helpful. Please feel free to ask any questions you have, and Brad or I will try to answer them.
Q. Well, you certainly painted a bleak picture above. Why not go to cash and wait out the Fed storm?
A. Mainly because no one rings a bell at the bottom of a downturn that tells you to get back in the markets. If you go to cash after suffering the losses, but miss a big part of the upturn, you will just lock in the losses and never recover. Sure, things look bleak now, but there are many things that could happen to change the narrative and start the market on a new upturn:
- Inflation could recede quickly causing the Fed to slow down their rate increases. This possibility is not that far fetched. Commodities have been down sharply, home prices have started coming down, retailers have large inventories they will have to discount to sell, etc.
- The war in Ukraine could end with some sort of settlement. Energy supplies could flow to Europe and the price of energy worldwide could decline.
- As a slowing economy looms, interest rates could move significantly lower. That scenario might have already started. The rate on the 10 year US treasury note hit 4% briefly last week. Today it came down to 3.6%. Lower rates could boost the stock market.
- A few corporations have issued earnings warnings, but most have not. Earnings are expected to decline, but what if earnings decline only a small amount? The markets would rally on that news.
Q. Now that interest rates are back to 4% for certain treasury bonds, why not invest only in bonds and forget stocks?
A. Jeremy Siegel is a professor of finance at the Wharton School of the University of Pennsylvania. He is a frequent commentator on business networks and wrote a classic investment book titled “Stocks for the Long Run”. The 6th edition of his book is now out and is completely updated with new data on the long term performance of stocks and bonds. He makes the case in his book that stocks over time outperform inflation with a 6.7% annual return. Here are some excerpts from an interview he recently did with CNBC:Asked about the 6.7% return of stocks and their ability to beat inflation, Dr. Sigel responded,
“despite all the ups and downs and crises, and bear markets that we’ve had over the last 30 years, the real return on stocks has been absolutely the same, which is really quite remarkable. And secondly, as you point out, not only do stocks tend to overcome inflation in the long run, they completely overcome inflation.”
When questioned about rising bond yields and stocks, he said,
“Now I know yields have gone up sharply. And some people have said, “My goodness 4% yield on (2 year) bonds, doesn’t that look good?” Remember that is 4% before inflation, take that and compare it with the long run real return on stocks, which is 6.7% after inflation. Tell me where you want to be.”
Q. Could we have another 2008 type recession and market crash?
A. Anything is possible, but we are in a very different environment now than 2008:
- Per Federal Reserve data, average household net worth going into the 2008 recession peaked at around $71,000. The latest amount for 2022 is around $144,000.
- Banks were undercapitalized in 2008 and suffered huge losses from defaults on mortgages. Regulations passed since the financial crisis require banks to hold more capital and homeowners to make higher down payments on their homes. Stress tests have shown that banks are in much better shape today if there is an economic downturn.
Q. In prior bear markets, stock investors had to wait years to recapture the wealth lost in the downturn. How many years will it take for me to get back to even?
A. Let’s look at the worst market periods in the last 100 years and the number of years it took to get back to even once the downturn was over:
Years to Breakeven | ||||
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Period | Number of Years | Loss % | Stocks Only | 50% Stocks, 50% Bonds |
1929-1932 | 4 | -64.20% | 12 | 3 |
1939-1941 | 3 | -20.50% | 2 | 1 |
1973-1974 | 2 | -37.10% | 2 | 1 |
2000-2002 | 3 | -37.60% | 4 | 1 |
2008 | 1 | -37.00% | 4 | 2 |
Note that an allocation with 50% stocks and 50% bonds got back to even much quicker than stocks only.
Q. How am I going to survive in retirement if my investments suffer losses similar to those above?
A. Even though bonds are having a terrible year due to the dramatic Fed rate increases, in most years that the stock market is down, bonds increase in value. When a client is in or near retirement, we hold back several years of living expenses in short-term bonds for safety. In a downturn, living expenses come from the short-term bonds first, followed by liquidation of other bonds. In most cases, equity funds have time to reclaim their value before they have to be used for expenses. So, even with the stock market down dramatically, your retirement should not be affected.
Disclosures
The opinions expressed are those of NBZ Investment Advisors, LLC (“NBZ”). The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. Forward looking statements cannot be guaranteed.
Material presented has been derived from sources considered to be reliable, but the accuracy and completeness cannot be guaranteed. Not every client’s account will have these exact characteristics. The actual characteristics with respect to any particular client account will vary based on a number of factors including but not limited to: (i) the size of the account; (ii) investment restrictions applicable to the account, if any; and (iii) market exigencies at the time of investment.
Any investment strategies presented may not be appropriate for every investor and individual clients should review with their financial advisors the terms and conditions and risk involved with specific products or services. As with all investments, past performance does not indicate future results. Investing involves risk including the potential loss of principal. Returns are presented gross and net of investment advisory fees and include the reinvestment of all income.
The S&P 500® Index is the Standard & Poor’s Composite Index and is widely regarded as a single gauge of large cap U.S. equities. It is market cap weighted and includes 500 leading companies, capturing approximately 80% coverage of available market capitalization.
The Bloomberg Barclays U.S. Aggregate Bond Index is a broad base, market capitalization-weighted bond market index representing intermediate term investment grade bonds traded in the United States. The Index is frequently used as a stand-in for measuring the performance of the U.S. bond market. In addition to investment grade corporate debt, the Index tracks government debt, mortgage-backed securities (MBS) and asset-backed securities (ABS) to simulate the universe of investable bonds that meet certain criteria. In order to be included in the Index, bonds must be of investment grade or higher, have an outstanding par value of at least $100 million and have at least one year until maturity.
The MSCI EAFE Index (Europe, Australasia, Far East) is a free float-adjusted market capitalization-weighted index that is designed to measure the equity market performance of developed markets, excluding the United States and Canada. The MSCI EAFE Index consists of the following 21 developed market countries: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland and the United Kingdom.
The Nasdaq Composite is a stock market index that consists of the stocks that are listed on the Nasdaq stock exchange.
NBZ is an investment adviser registered with the U.S. Securities and Exchange Commission. Registration does not imply a certain level of skill or training. More information about NBZ’s investment advisory services can be found in its Form ADV Part 2, which is available at nbzinvest.com or by calling (865) 584-1184. NBZ-22-05.