The stock market entered a bear market last week, causing some fear and concerns like we haven't seen since March/April of 2020. We know this definitely feels like something new we haven’t seen before. However, we still feel that this is a normal market decline and that we will recover. With many of our clients, we utilize our three-bucket strategy to provide "All Weather Investing", and this strategy has worked. In a down market, your short-term Bucket should outperform your mid-term Bucket, and that should outperform your long-term Bucket, and that's exactly what has happened. For those in the accumulation phase and are primarily invested in a long-term Bucket, do not be concerned. This time is really not so different, and this is not 2020 or 2008. Here's our thoughts on a recession, and investing in stocks and bonds:
Q1 2022 we achieved negative GDP growth. Some believe that we will show low but positive GDP growth in Q2 2022. This means we are not in a recession and there may not be one anytime soon. Others believe we are already in one and we will know in July when the GDP numbers roll out for Q2. If negative, we are in one but it will only feel like a bear market.
As rates increase, the economy slows. It’s believed we will have increased unemployment due to less jobs which will also cause wage growth to slow. If significant layoffs happen, this could cause a recession. Many believe that if this is the case, a recession wont happen until 2024.
Inflation is a byproduct of both the Trump and Biden administrations because of COVID-19. Trump started it, Biden continued it. We are feeling the hangover of throwing a massive amount of money into the economy in addition to supply chain issues.
Energy prices are a reflection of Biden’s green policies and anti-energy independence stances. He may have political pressure to soften his stance as we get closer to the mid-term election.
Real Estate is not in a bubble. There is still too much demand in comparison to supply. There is more demand now than there was in 2007 and there is half the supply. There was a bubble in the rate in which real estate appreciated. We will not see the same growth rate but real estate prices will continue to rise at a modest rate regardless of interest rates.
It feels like there’s always a reason to sell your stock positions. Today it’s inflation, gas prices, a president that you don’t like and a war. COVID 19, Brexit, 9/11, Dot com bubble, Black Monday, etc. were among others. Since 1936, the S&P 500 has an average rate of return of returned 10.59% per year. Would any of these events scared you out of good investments? Stay invested and you’ll do fine.
By selling, you’re realizing the loss and now are losing purchasing power due to inflation by holding too much cash. Once inflation starts going the other direction (and it will), we should see a rally in the stock market. Additionally, if we see a red wave during the mid-term election, it is believed the market will have a nice year end rally. The market loves a divided government as no significant policy changes can be made. US companies are profitable and there are still 2 jobs for every 1 person looking.
If you invest in the stock market, historical trends suggest you could see the following, with big corrections usually only occurring in recessions.
Time in the market is more important than timing the market. The only person that gets hurt on a rollercoaster are the ones that jump off. The best days in the market tend to immediately follow the market decline.
Recoveries were strong in the five biggest market declines including the great depression and great recession. Here's the market returns for the 5 years after these market declines. We are not saying that what caused these declines are similar scenarios to today, but this does provide a historical worst case reference.
Bonds normally have uncorrelated returns with the stock market. There are times when that doesn’t always happen (correlated in 2008/2022, uncorrelated in 2020). When interest rates rise, bond prices fall and this is what investors have experienced this year. During a rising interest rate environment floating rate (bank loans) and alternative strategies tend to do well.
Bonds with shorter durations (maturities a year or less) tend not to be as volatile. Today they are at a discount, but when they mature (at 100 cents on the dollar), the money can be reinvested in bonds with a higher yield.
Intermediate duration bonds (maturities of 5-6 years) have a higher yield today (around 4-5%). These bonds have got hit the hardest but moving forward the uncorrelation of returns with stocks should normalize. If the Fed overshoots interest rates and pushes us into a recession, it’s likely they will reduce interest rates again. These types of bonds tend to outperform in this scenario but still provide a nice yield while you wait.
We employ all of these strategies in our Bucket #1 and believe we’ll see positive bond returns over the next 12 months.
Here’s what’s currently priced into the bond market:
- .75% rate hike in July
- .50% in September, 50% chance of .75% hike
- .25% in November, 86% chance of .50% hike
- .25% in December, 35% chance of .50% hike
- 75% chance of hike in February
In the end, we believe this is not a time to panic. Regardless of what happens in the coming months, we believe if we fast forward 3 to 5 years from now, everyone that stays invested, will be happy they did so. Remember, we are here for you and are happy to discuss any concerns you may have. Please do not hesitate to reach out to schedule a time to meet.