So far in 2022, the markets are off to a rocky start. The pullback has been global and there have been very few places to hide. The following are examples of some year-to-date returns (as of 2/18/2022):
|Dow Jones Industrial Average||-7.22%|
|U.S. Corporate Bonds||-5.84%|
So why are markets down?
Every day, the mainstream media comes up with different reasons for the pullback (they have to, it’s their job). In the investment business, we call this noise. If you take a step back and look from the top down, you will see there are only a few reasons why.
First, there is an old Wall Street expression that says, “Don’t fight the Fed”. The Federal Reserve Board has indicated that they are moving from an “easy” monetary policy to a “tighter” monetary policy. The main reason for this is that inflation finally caught up to us. In 2020, the world came to a halt due to the Covid-19 virus. The disruption to businesses around the world was devastating. In order to combat this, central banks around the world cut interest rates to 0% (in some countries the rates even went negative) and pumped their economies with easy money. The chart below shows the U.S. M2 money supply. This is the amount of money circulating in the United States. As you can see, it grew dramatically between 2020 and today.
As we have come out of the pandemic, demand for goods and services has outpaced supply and this continues to be the case. You have probably heard the media talking about supply chain and labor issues. This is the definition of inflation! If you remember Econ 101, inflation is “too much money chasing too few goods”.
The fear is that the Fed moves too far and causes the next recession. Going back to the 1950’s and looking at 12 rate-hike cycles, a recession doesn't come for 41 months (on average) after the Fed begins raising rates. It could be as soon as 11 months or as long as 86 months. This may surprise you but the average return for the S&P 500 from the first rate hike in each cycle is over 14% annualized.
Second, there is much uncertainty around Russia’s potential invasion of Ukraine. This uncertainty has led to further momentum to the downside and stocks generally go down a lot faster than they go up. Most of the time, these types of geopolitical events are short-term in nature and don’t change the fundamentals of our stock market. Fear, however, is a powerful motivator.
Lastly, there has been a big shift from growth to value. Momentum in growth stocks reversed and the money coming out of those stocks has been repositioning into the neglected value stocks like those in the energy sector. Also, due to the inflationary pressures explained earlier and the rise in commodity prices, money has been flowing into Gold and Oil. This didn't just start this year. All of this began as early as February 2021. That was the peak of the “meme” stocks and funds like the ARK ETFs.
What's an investor to do?
For a long-term investor, plan to conduct a review to ensure your asset allocation continues to align with your financial plan and risk preferences. If you are uncertain about your situation or you got caught up with trading all of the no-earnings growth stocks or “meme” stocks that were booming last year, don’t put your head in the sand. Now is the time to take a hard look at your portfolio and make the changes necessary to turn things around. If you have any questions or would like us to take a look at your portfolio, let's schedule some time to discuss.