“Real optimists don’t believe that everything will be great. That’s complacency. Optimism is a belief that the odds of a good outcome are in our favor over time, even when there will be setbacks along the way.” -Morgan Housel, The Psychology of Money
The first half of the year was definitely one that we would like to move on from. (In fact, it was the worst first half for the stock market since 1970) However, as investors, we know that we will deal with markets like this from time to time.
About 20% of the time, we get negative years in the market [1]. They are temporary setbacks, the fee or premium that we have to pay in order to receive the positive returns that stocks give us 80% of the time.
Stocks have given us a higher historical average return than other asset classes over time and we have definitely had some good returns over the last few years. But those returns aren’t free. We have to earn them. Being diligent through volatile markets is how we do that. I like to say that we want to get paid for taking risk and high-quality stocks have consistently paid off over time. More importantly, our risk assets like stocks are essential for most us to achieve an adequate return over inflation to support our financial plans.
Coming in to 2022, we knew that there may be some rocky times ahead. The mid and late business cycle phase of the economy naturally produce corrections in the market. However, this year brought a trio of challenges that not many investors expected.
China has continued to have ongoing shutdowns while trying to cope with Covid in their own unique way. This has prolonged the supply chain issues that many analysts thought would be resolved at this point.
The Ukraine-Russia war has put pressure on the global economy and spiked commodity prices.
And, our own economy has run too hot on the crutch of government stimulus, leaving the Fed to take actions to decelerate our growth.
Any one of these items on their own would be a headwind for the market, but we have dealt with all 3 in the last six months and the result is high inflation that has persisted longer than it should have.
The good news is that we know the problems and we know that they are temporary.
Here are some key stats to know:
Once a -20% bear market has been reached like we saw last month, the average return 12 months later is +17.4%. [2]
Over the last 50 years, when the market is in correction it has taken 7 months to get back to its previous peak when there isn’t a recession. The less frequent recessionary corrections have taken an average of 36 months to get back to the peak.[3]
Source: Fidelity Investments
We will be watching some important data over this quarter, and we hope to see that the pressure is easing so that the recovery can get underway. We saw some positive signs of this today. June’s inflation data was released, and it was higher than expected. However, the market reaction was pretty mild with some initial selling early in the day, but then the indexes trimming most of the losses by the end of the day and finishing basically flat. This is most likely because the inflation trade has already happened, and investors know that the inflation data is old. We have seen commodity prices come down significantly over the last 30 days which leads some economists to predict that inflation may have peaked in June. (See Jurrien Timmer Article linked here).
The direction of inflation over this quarter will have a big impact on our expectations for a quicker or a more prolonged recovery as we see inflation as the major contributor to a recession. Over the last few months, the probability of a near-term recession has increased quite a bit, but there seems to be a divide among economists on the likelihood and the severity of a recession.
Source: Capital Ideas
Here are some examples of the ongoing commentary:
The International Monetary Fund has cut its U.S. growth projection from 2.9% to 2.3% and warned avoiding a recession is increasingly challenging.[4]
“The U.S. economy looks able to withstand higher interest rates and will likely slow rather than contract, Capital Economics chief North America economist Paul Ashworth says in a note. “Households and businesses appear to be well-placed to cope with higher interest rates as balance sheets are in good shape and rate-sensitive spending isn't a big part of the economy,” he says. “Pent-up demand from the long period of supply shortages could keep the economy afloat for a year, while a drop in commodity prices should also support incomes. There is still a good chance that, as supply improves, inflation will fall back markedly, without the need for a massive decline in demand or a significant rise in the unemployment rate."[5]
“The environment is changing rapidly, and significant headwinds have emerged,” says U.S. economist Jared Franz. “But clear areas of strength can be found across the American economy.” Is a recession on the horizon? “Recessions are a natural and inevitable part of the business cycle, and a downturn is likely on the horizon,” says Franz. “That said, I expect the next recession to be a healthy correction that addresses imbalances, not the kind of wipeout investors endured in 2008.”[6]
As we read through all the data and commentary that is given to us on a daily basis, it is easy to feel overwhelmed. The direction of the economy and the markets is out of our control. In times like this, it is important to control your controllables! When it comes to your investments, here are the things that I suggest focusing on:
Control how you digest the news. Remember, that headlines are just trying to get your view or your click. It is easy to get sucked in to meaningless or redundant news. With the markets, often the latest headlines are already priced in, and most of the headlines are not going to change your investment strategy anyway. So try to stay informed but not alarmed.
Control your perspective. Remember that even in the worst bear markets, stocks typically achieve new peaks in about 3 years. For bonds, the rebound is typically within 1 year. There is so much data out there about staying invested. It is so important to stay focused on your long-term returns. We need to give ourselves at least 3 years for any money that is invested in stocks, and I propose that you should have at least a 5-year time horizon.
Stick with the fundamentals. If your investment allocation is appropriate for your risk tolerance from the start, then you typically shouldn’t make a change. Times like this may push your tolerance to the max, but you have planned for this and it is important to follow the plan.
Make sure to reach out if you need to discuss any details of your personal investment plan. It is important to talk through the challenges that this year has introduced and we are happy to help!
Centered Financial, LLC is a registered investment adviser offering advisory services in the State of California, Utah, Texas and in other jurisdictions where exempted. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. There is no assurance that the techniques, strategies, or investments discussed are suitable for all investors or will yield positive outcomes. To determine which strategies or investment(s) may be appropriate for you, consult your financial adviser prior to investing. Any discussion of strategies related to tax or legal planning is general and is not intended as tax or legal advice. Please consult appropriate tax and legal professionals for recommendations pertaining to your specific situation.
[1] Data from 1980 JP Morgan Asset Management GTM Q3 2022 U.S. 16
[2] Focus Point Solutions June Adviser Meeting proprietary calculations; Yahoo! Finance Data from 1950.
[3] History Suggests this Isn’t the Time To Sell Whitepaper. Denise Chisholm. Fidelity Investments June 2022.
[4] Atom Finance; Atom Daily Digest 7/13/22
[5] WSJ. Wealth Adviser Briefing. 7/12/22
[6] Capital Ideas. U.S. Outlook: Time to Pursue All-Weather Investing. 6/9/22