Broker Check

Standing Firm in Trying Times

July 19, 2022
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You do not necessarily need a table like the one above to know that markets have had a tough time this year. However, it can be useful to review the numbers to put this bear market into perspective. Equities, as measured by the S&P 500, the tech heavy NASDAQ, and the developed international MSCI ACWI, are all down this year by 19.96%, 29.22%, and 18.15%, respectively. Fixed income, as represented by the Bloomberg Agg index, is also down by 10.35%. This decline in both stocks and bonds is rare, given the historical lack of correlation between the two. One major culprit for the decline in both these asset classes is higher interest rates, which the Federal Reserve has committed to raising to combat decades-high inflation levels of 9.1%. As a result of these hikes, the benchmark 10-Year Treasury yield has increased an astonishing 105.2% over the course of one year. This large and rapid increase in interest rates caused fixed income investments to decline in value by levels not seen in four decades.

In terms of severity of this quarter’s downturn relative to history, both equity and fixed income have experienced declines with little precedence. In the second quarter of 2022, according to FactSet, the S&P 500 declined 16.73% while the Bloomberg Agg declined 4.44%. There have been few quarters as bad or worse than this. For the S&P 500, only 5% of quarters going back to 1928 have been as bad or worse than Q2 2022. For the Bloomberg Agg, a mere 3.6% of quarters going back to 1976 have been as bad or worse than Q2 2022.

Poor returns in the market have been accompanied by mixed results in the real economy. We can zoom into two particular areas, employment and housing, to illustrate the complex economic situation we are in, with data provided by FactSet. On a positive note, the unemployment rate currently stands at 3.6%, only slightly above the pre-pandemic multi-decades low of 3.5%. This low unemployment rate would ideally lead to increased pay for workers. However, any nominal gains in pay have been wiped out by the

oppressive weight of inflation, with real wages falling 1% month-over-month, per the Bureau of Labor Statistics. Housing presents another mixed message. Home prices are at all-time highs, as measured by the Case-Shiller Index, but existing home sales have dropped each month for the past 4 months. These high prices but slowing sales suggest that we may have reached a peak in the housing market.

Overall, the near-term financial picture looks gloomy. The markets have undoubtedly experienced recent turmoil, and the real economy may soon follow suit. While the labor market remains robust, it may be to the point of potentially causing labor shortages. This, combined with high inflation and supply chain backlogs, may lead to a recession. Officially, a recession is defined as two consecutive quarters of negative economic growth. The first quarter of 2022 saw a GDP decline of 1.6%, so after second quarter GDP figures are released on July 28th, we will know if we are in a recession. Regardless of if the economy meets the technical definition of a recession, according to a June 14th poll from The Economist/YouGov, 56% of Americans believe we are already in one.

The downturn in the markets and the uncertainty in the economy may be concerning, but for the long-term, diversified investor, these immediate issues do not pose an existential problem. It is important to step back and look at the bigger picture. First, while declines are painful, it is important to remember that history has shown us that markets do eventually come back. First Trust created the table below showing various percentage declines and how long on average it took to recover from them. As of July 1st, 2022, we are about six months into the bear market, or more than halfway through it based on historical averages.

Second, the growth generated by compounded returns over time presents a huge wealth building opportunity, even if there are market declines along the way. According to data from First Trust, going back to 1970 through March 31, 2022, the average annual return of the S&P 500 has been 10.88%. This average includes time periods that have seen some of the sharpest downturns in stock market history, such as the Black Monday Crash of 1987, when the Dow Jones dropped 22.6% in one day, or the Global Financial Crisis of 2008-2009, when the S&P 500 lost 56% of its value at its worst point. During periods of market turmoil, these downturns can certainly be nerve-wracking. However, when viewed with a long time-horizon, staying invested and sticking to your financial plan generates the best results. Below is a chart showing the power of compounded returns over time. It plots the growth of $10,000 if it were invested in the S&P 500 in 1970. You will notice labelled on the chart major periods of geopolitical and economic uncertainty. You will also notice, however, that despite the barrage of headlines across time, the chart continues to grind higher, with $10,000 growing into $2.2 million. This is the power of standing firm even in trying times.

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