2022 has proven to be a difficult year thus far. If it feels like it’s been a volatile year for stocks, it’s because it has been. Nearly 90% of all trading days in 2022 saw markets move at least 1% or more in either direction. For some context, in 2017 this occurred on fewer than 10% of trading days.
Stocks are suffering their worst start since the infamous 1930s. Adding insult to injury, bonds have also struggled due to inflation and rising interest rates. Given the current market gyrations, some analysis is necessary and appropriate, as are a few deep breaths.
It’s prudent to first remind ourselves about the headwinds we saw heading into 2022 — higher inflation, higher interest rates, and midterm election uncertainty. Coupled with an unexpectedly brutal war between Russia and Ukraine, many of these headwinds have gathered speed.
The highest level of inflation in over four decades has forced the Federal Reserve to aggressively hike interest rates. Many have asked if this action hurts stock prices. The answer is yes, it can slow the economy and take a toll on stocks in the short run. However, using the past 12 U.S. rate-hike cycles as a guide, we see that stocks were decidedly positive throughout each. In other words, breathe through the immediate pain and let the market run its natural course and heal.
Due to the anticipated higher interest rates in 2022, I expected dividend-paying, value-oriented stocks to fare better than their growth and technology counterparts. So far, this trend has played out. Through mid-May, value stocks have significantly outperformed growth stocks.
The excesses that were visibly building in the many corners of the market in the last few years are beginning to unravel. Think of the profitable “stay at home” tech companies that were trading at 100 times sales. Many of these areas have come back down to earth, falling more than 80% in price. The unfurling of these COVID excesses has caused the overall market consternation. That said, companies with reasonable valuations and strong balance sheets that pay and grow their dividends continue to be solid options for investing.
While drawdowns can be harrowing, it’s worth remembering this is a normal part of investing. Going back to the late 1920s, the average annual drawdown in the S&P 500 is -16.3%, or about in line with this year’s pullback. Perhaps more amazing is that despite this level of average drawdown, 69 of the past 94 years have seen positive annual returns.
Investing will always have its ups and downs, but I continue to believe that a portfolio of high-quality, dividend-paying stocks and income-producing bonds will withstand most environments over time.
A rough start to the year typically leads to a much better second half. 2022 ranks as the third-worst yearly start going back to the Great Depression. When looking at nine of the other bad ones, stocks finished the year on average up 10%. Bad starts generally signal that much of the damage is done. I’ve always been fond of the saying that the cure for low stock prices is . . . low stock prices.
Are bonds and fixed income suffering as well? Yes. Anytime interest rates rise in a significant way it creates indigestion for bonds.
More importantly, long-term bond returns are highly correlated to starting interest rate levels. Since the 10-year U.S. Treasury bond has risen from near zero percent during COVID to having touched over 3% recently, the outlook for receiving higher interest payments and higher fixed income returns has improved dramatically.
Will the U.S. go into a recession in 2022? I tend to think the rest of the year will be relatively strong. Despite a slightly negative gross domestic product the first quarter of 2022 (-1.4%), the Federal Reserve is doing everything it can to tame inflation without a large economic contraction. It’s a difficult needle to thread.
The U.S. labor market is so strong that raising interest rates may be the parachute the Federal Reserve needs to engineer a soft landing. There are currently 11.5 million job openings in the U.S. and less than 6 million people unemployed. Having 5.5 million job openings gives me some optimism.
The bottom line is that despite some cross currents in the market for the beginning of the year, the latter half of 2022 may provide some relief. Patience continues to be a virtue for investors, and I still believe that well-balanced, multi-asset income-producing portfolios are a cornerstone to helping families work towards their retirement goals.
Read the original AJC article here.
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