Jun 18, 2022 FAS Market Update June 2022
Posted By FAS Team
Climate is what we expect, weather is what we get.” – Mark Twain
Seasonal cycles are a fact of life. We understand from long term experience fall leads to winter and winter leads to spring and so on. This is the climate cycle which we prepare for and harness to support our ways of life. Weather is the chaotic day to day events which cause tornadoes here in the Midwest or hurricanes in the Gulf of Mexico. Both are normal patterns and are expected as part of seasonal cycles, neither last indefinitely.
Cycles apply to the financial markets as well. Investors experience an oscillation between bull and bear markets. We view this as the natural climatic rhythms. Additionally, the day-to-day changes can be volatile, like the weather events we experience. Accepting these cycles as a normal condition for long term investing can help to calm our active minds which may lead investors to “take action”. Often during stressful times, actions taken lead to poor choices in relation to our long-term goals.
Yesterday’s market results can be categorized as a weather event with many indices finishing down 4-5%. As a result, the bear market we wrote to you about in May became “official” with the S&P 500 closing down roughly 22% from recent highs through the close. From their respective highs, the aggregate bond market is down ~14%, the Nasdaq is off ~33% and small company shares are down ~30%. Yesterday’s finish for the bell weather index marked the official change in seasons.
Currently, there are no lack of concerns for traders. Supply chains continue to be disrupted from China’s zero COVID policy and labor shortages. The ongoing war in Ukraine continues to elevate commodity prices and lower investor sentiment due to the threat of a larger global conflict. However, the primary driver of this market decline is the high levels of inflation and the implications to monetary policy.
Last Friday, the bureau of labor statistics (BLS) released US consumer price index (CPI) measurements for May. The hope was a continued decline in CPI which would indicate peak inflation had occurred. Unfortunately for the headline figure, which includes food and energy costs, inflation accelerated to 8.6% from the 8.1% observed in April. Market reactions implied a more aggressive Federal Reserve response through higher-than-expected rate increases. The significant recent broad price declines are largely in response to the Fed’s goal of containing inflation by slowing aggregate demand potentially pushing the US economy into a recession. For long term investors, a wintry season has arrived.
Even though it is a difficult period, there are reasons to be optimistic for the future. Seasons change and typically some of the strongest market returns have followed bear markets. The table below provides periodic returns after the date of official bear markets going back to 1957. Over 1- and 3-year periods of time, the S&P 500 is positive with cumulative returns of 15% and 30% respectively.
Leading up to 2022, we had prepared portfolios for higher interest rates and increased volatility by lowering maturities in the bond portfolio, reducing small company exposure and weighting more towards value investing, amongst other changes. After the broad asset selloff, higher interest from bonds and lower stock valuations have boosted our future return assumptions within financial plans from more moderate levels
The S&P 500’s forward price to earnings multiple is now under its 25-year average, generally good for annual returns over a market cycle. Perhaps the largest contributor to increased portfolio returns is the adjustment to interest rates. High quality income has been a challenge to find up until recently. As an example, the benchmark 10-year Treasury yield has more than doubled from 1.51% to begin the year to 3.37% as of yesterday. This has led to many attractive investment opportunities across bond sectors.
Even with portfolio adjustments it is extremely difficult, if not impossible, to completely weatherproof portfolios. Which is why our advisors view financial plans as a critical component to long-term investing success. Developing strategies to align our clients’ assets with their various goals better allows for endurance when these inevitable difficult seasons arrive. We don’t know when, but history shows after these painful bear markets the investing climate improves welcoming back sunnier days.