If you’ve been an investor in 2022, you don’t need us to tell you how tough things are. In order to tamp down inflation, the Federal Reserve is deliberately trying to make stock prices go down, crash the housing market, and slow down the overall economy.
For the most part, it’s worked. The stock market is officially in a bear market. The housing market has dried up, and it is almost certain that we are either in, or entering, a recession.
Here are the returns for the stated indices through November 7th:
|AGG Bond Index
As you can see, it isn’t only the stock market that has taken it on the chin. The “conservative” bond investments have also been taken to the woodshed.
By the Fed raising the Fed-Funds rate under their control, the other interest rates on government and corporate bonds have followed their rise, pushing down prices of existing bond holders. This has caused an extremely unusual reaction in the bond market – a double-digit percent correction. If the year would be over today, it would be the third worst calendar year for the observed 60/40 portfolio.
Charted below is a list of the worst years for a 60/40 portfolio. (Constituting 60% S&P 500 and 40% 10-year treasuries):
These returns may surprise you. How are we down so much more now than we were in 2008, during a real financial crisis? Or in 2001 when the dot-com bust cut the S&P 500 in half?
The answer is the diversification aspect that we expected from bonds, or the lack thereof. For example, in 2008, equities were down -36.6%, quite a chunk lower than what equities are down now. Conversely, bonds were up 20.10%. Since 1928, there have been only four points in time where stocks and bonds have been down in the same year. And when that did happen, most were in the low single digits.
So, where is the good news?
The good news is that, if history is any guide, things will be looking quite positive from here on in.
First, on the fixed income side of things: A year ago, the yield we were getting from a ten-year bond was .74%. A two-year bond was yielding .49%. With that backdrop we were at a starting point of almost no yield, making it very hard to diversify portfolios. Now, these same bonds are yielding in the 4% range. So, the bond portion of the account will earn a yield, providing investors with a fixed income and a benefit from diversification.
As for equities, there is also a historical precedent for a comeback. Look below at what happens when the S&P 500 falls by 25% or more:
Source: A Wealth Of Common Sense
This isn’t to say the low for the year is in, or that there won’t be any gut-wrenching volatility until year end. But for those courageous enough to hold on, history proves that they will be paid back nicely.