Q1 2022 Commentary
By Ryan and Mike O’Donnell
What happened in the U.S. and abroad?
With the highest inflation in 40 years, on top of Russia’s invasion of Ukraine, the Fed raising interest rates for the first time since 2018 and a new COVID variant emerging, there were plenty of headwinds for the economy and financial markets in Q1. I’m not going to sugarcoat it:
US stocks: -5.28%
International Stocks: -4.81%
Emerging Markets: -6.96%
Bonds: -5.93%
But as Abraham Lincoln liked to say: “This too shall pass”
Beneath all these exogenous factors, company earnings remain strong, the economy is still growing, jobs are plentiful, and interest rates are still near their historical lows. When you start looking at longer term periods since 1928, stocks have never had a negative return over any rolling period longer than 10 years. Most other asset classes follow a similar pattern.
Bond market
One thing that stands out for me amid all the red on the screen is the sharp decline in the bond market. Conventional wisdom is that bonds are the safe part of your portfolio, but the Bloomberg Aggregate Bond Index was down 5.93% last quarter – its worst three-month run since 1980. It's important to know why. The price and value of a bond is directly tied to current interest rates. As rates rise, the price of a bond falls. When the bond matures (or the money is reinvested) it's reinvested at a higher rate. And as I’ll touch on in a minute, that’s not necessarily a bad thing, especially for savers and retirees as they can garner some badly needed yield with the right strategy. While no one knows for sure where interest rates are headed, the Fed has signaled up to seven or eight rate increases are likely in the next 12 to 18 months. Don’t bet on lower rates for the foreseeable future.
Investing in fixed income is fluid, meaning bonds are maturing and being reinvested. So, it's a hard asset class to view at a static point in time. Just know The Fed has raised rates aggressively a number of times over the past 30 years, most memorably in 1994-1995 when it raised rates by a full 3%. It also raised rates by a total of 1.75% in 1999-2000, by 4.25% from 2004 to 2007, and by a total of 2.25% between 2015 and 2019. In every single one of those rate raising periods, the various bond indices returned +4% on an annualized basis.
Major headlines from the past 3 months?
“Interest-Rate Worries Batter Stock Market; Nasdaq Sinks More than 3%”
“S&P 500 Falls into Correction Territory as Russian Troops Enter Ukraine Region”
“US Inflation Reached 7.9% in February; Consumer Prices Are Highest in 40 Years”
“Fed Raises Interest Rates for First Time since 2018”
“Gas Prices Shoot Up at Fastest Rate on Record”
Diversification
Portfolios with larger allocations to stocks are considered riskier, but they have higher expected returns over almost every time period. Study after study shows you are unlikely to achieve your financial goals without having some level of risk in your portfolio. With that risk, you’ll have volatility from time to time. But sticking to your plan will get you through the bumps in the road.
Is it time to sell stocks?
Is inflation bad for stocks. Do the losses in popular tech stocks signal a downturn ahead for the broad market? Should I be doing something different in my portfolio? This is just another version of the market timing question? It’s almost impossible to know when to get out (or pare down) and when to get back in. Meanwhile, the time you spend on the sidelines can be very damaging to your portfolio.
As a thoughtful financial advisor once observed, “A portfolio is like a bar of soap. The more you handle it, the less you have.”
