We are 10 months into the year and the markets are continuing to experience declines and high volatility. As we pointed out in our previous update in April, the major culprit is inflation. Below is the current chart of the Consumer Price Index (CPI). Inflation continues to be stubbornly high even as the Fed has raised interest rates at the fastest pace in history (price stability or managing inflation is one of the Federal Reserve Board's primary mandates). Based on recent data, many would argue the rate hikes are doing their job. However, there is a lag effect with much of the data including rents and home prices. There is little argument, however, that the rate hikes have begun to take their toll on the economy at large. The economy shrank in the first six months of the year and forward-looking measures of activity suggest the situation has not improved. If we are not already in a recession most economists predict that we will be by 2023 (ignoring how politicians may try to change the definition of a recession). Although this is the case, the Fed has indicated that it will continue to be aggressive in its fight against inflation.
What does this mean for the markets?
Below are some year-to-date numbers for the markets:
|S&P 500||- 22.10%|
|NASDAQ Comp||- 31.73%|
|MSCI EFA (International Stocks)||- 27.60%|
|U.S. Aggregate Bond Index||- 16.78%|
Returns are as/of 10/20/2022
As in most bear markets, there has been nowhere to hide. When the stock market is in bear territory, investors will typically look for safety in bonds. Since interest rates were at historic lows and yields have risen across the yield curve, investors have also sold their bonds (prices and yields are inversely related). As you can see in the chart below, this has been the worst year for bonds (as measured by the U.S. Aggregate Bond Index) in the history of the index. Subsequently, according to BAML, this is the worst year for a 60/40 portfolio (60% equities, 40% bonds) in the last 100 years. This mix is often a proxy for a long-term investor’s “moderate” asset allocation portfolio.
What should an investor do?
Studies have shown that the biggest determinant of return in most investors’ portfolios is not the performance of the underlying investments but the behavior of the investors themselves. For example, we just told you that the 60/40 portfolio is having its worst year in 100 years. If that were your portfolio, how would you feel? Would you consider selling everything immediately? If you were contributing to this portfolio regularly, would you consider stopping new investments? Or would you invest more arguing that this presents a great buying opportunity?
Market volatility and bear markets are always unsettling but historically they are not unusual. If you have an appropriately-diversified portfolio that matches your time horizon and risk tolerance, it is likely that this current bear market will turn out to be a proverbial "blip" in your long-term investment plan.
Right now, here are 2 things to consider:
Tax loss harvesting – do you have losses in a taxable account? Although selling at a loss isn’t always easy, you can use those losses to offset gains in the current year thereby mitigating capital gains taxes. You can also use up to $3,000 in losses per year to offset ordinary income until the entire loss is accounted for. You have to wait 31 days to buy back the same security that you sold or you can find a similar, but not identical investment, to reinvest in immediately. (Of course, always consult with your tax advisor first).
Continue with regular investments – Finding the perfect time to invest is nearly impossible. While staying the course and continuing to invest when markets dip may be hard on your nerves, it can result in greater accumulated wealth over time. If you are behind on your investment goals, try to find a little more savings in your budget to increase your contributions while things are down. Historically, the returns following a bear market are above average.
If you are unsure about your investment goals and/or your risk tolerance or have any questions or comments, please reach out.