A Rough Start to the Year

It’s been a rough start for the year in the stock market. To find a worse performance through the end of April, you have to go all the

way back to 1970. It gets far less press but this has also been the worst start to the year for the bond market, going back to 1990. It’s not necessarily the depth of the declines that are hurting, it’s that it’s happening in stocks and bonds at the same time. This has been a painful environment because there really has been nowhere to hide.

Most everyone understands that when they invest in the stock market, there will be ups and downs. In exchange for dealing with the ups and downs, investors normally are rewarded with higher returns over time. Most investors also understand how diversification is supposed to work; when stocks go down, the bonds / fixed income side of my portfolio will buffer the downside. Well, that’s not happening at the moment, which is why, along with inflation, a war, and other factors, this environment feels really bad. These stats tell the story of how rare the current environment is:

  • The last 8 times the S&P 500 was down in a calendar year, Bonds finished the year up, cushioning the blow. Very different story thus far in 2022

  • Number of times US stocks and 10 year bonds have been down in the same year the last 100 years? Twice.

  • With data going back to 1976, this is the first time ever that both stocks and bonds are in a >10% drawdown at the same time.

Going back to 1950, the S&P 500 has had a positive annual return 56 out of 71 years, or 79% of the time. But as we know all too well, stocks don’t go up in a straight line. Temporary declines never feel that way in real time. The average intra-year drawdown going back to 1950 is 13.6%. Interestingly, that’s almost exactly where the market closed on Friday. We’re seeing some individual stocks (and not small ones) have very large declines. We’re seeing losses in bonds that we haven’t experienced in four decades. We’ve got inflation and the Fed removing liquidity from the market. So while it’s factually true that we are right at the average drawdown, there are all sorts of reasons why 2022 doesn’t feel average.

It’s a difficult environment for investors and nobody knows when it is going to get easier. You’ve heard this from us before but it is worth repeating. Making big changes to your investment strategy now, during periods of heightened fear and volatility, is probably not a great idea. Changing strategies or asset allocations in response to recent market events may make you feel better for a short while, but it is almost never a good long-term idea. This is true for us as advisors as well. We are not going to throw diversification out the window just because it hasn’t helped over the last 6 months. I strongly believe that having a rules-based process helps in times like these. The goal of our AFP Defined Risk strategy is not to prevent all losses within a portfolio. It is impossible to prevent all losses. We are trying to prevent catastrophic losses. Following a process is also a way to logically counter our human tendency to overthink and outguess where the market will go next and end up derailing our own plans.

The news is not all bad. The reason bonds are down is because interest rates are rising. While this is painful in the short-term, over the long-term that means higher returns for fixed income investors. Historically, the higher the starting yield, the higher the forward returns are for bonds. Higher yields will ultimately be a good thing. Newsflash – buying stocks when they’re on sale tends to be a winning strategy over the long run. Every correction can feel like it’s going to be the end of the world, but most of the time the world does not in fact come to an end. Volatility can create opportunities and we will be looking to take advantage of these opportunities as they present themselves. In 59 of the last 94 years there has been a double-digit correction in the S&P 500, so double-digit corrections are pretty common. In those 59 years, 58% of the time the market finished positive for the year and 39% of the time the market finished the year with double-digit gains.

Bottom Line: It has been a very rough start to the year but it’s important to remember that investors who are patient enough to deal with difficult times are usually rewarded in the long run. “The stock market is a device for transferring money from the impatient to the patient.” — Warren Buffett

As always, please give us a call if you would like to discuss your investments and/or your financial plan.

- Brett

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