This week’s eLetter comes from our colleagues at Lincoln Financial Services, just one of the fine organizations we regularly work with. We are pleased to pass it along and hope you find it useful. — Ron 

During the pandemic in 2020 and 2021, the world and markets had to adjust to a new landscape. We yearned for a return to normal. While the reopening has continued in 2022, it has had a different set of problems and has been both difficult and disappointing on several fronts. Pent-up demand met with a snarled supply chain disrupted the flow of goods. Inflation surged to levels not seen in decades.

% Return as of 6/30/2022

Equity Indexes 2nd Q YTD 3 Yr
S&P 500 -16.1 -20.0 10.6
Russell 2000 -17.2 -23.4 4.2
MSCI EAFE -14.5 -19.6 1.1
Emerging Market -11.4 -17.6 0.6
Wilshire REIT -5.4 -14.9 7.4
Bond Indexes
TIPS -6.1 -8.9 3.0
Aggregate -4.7 -10.3 -0.9
Government -3.7 -9.0 -0.8
Mortgages -4.0 -8.8 -1.4
Investment Corporate -7.3 -14.4 -1.0
Long Corporate -12.8 -22.7 -2.3
Corporate High-Yield -9.8 -14.2 0.2
Municipals -2.9 -9.0 -0.2

 

After heavily stimulating the economy with ultra-low interest rates, the Fed apparently kept its foot on the accelerator for a bit too long. To cool the overheated economy, the Fed has raised interest rates three times this calendar year and has vowed to continue until inflation is under control. Throw in the uncertainty of the Ukraine invasion and markets were in for some tough sledding.

 

Few places to hide

Investment markets ended the first half of 2022 with both equity and fixed-income markets in the red. The S&P 500 lost roughly 20% year-to-date. Of course, as we have noted before, while painful, 20% declines are not uncommon. A bear market has occurred, on average, every 3.6 years. The last bear market was in 2020 – probably more recent than one might think.

What makes this decline feel somewhat worse is that rather than supporting the overall portfolio in troubled times, bond prices fell as well. The Barclays Aggregate, a measure of the total bond market, fell about 10% in the first half of the year even as stocks also declined. This is uncommon. Since 1926, there have only been two calendar years in which stocks and bonds both went down.

 

Prudent investing still works 

Just because the decline was broad does not mean our long-held investment principles didn’t apply. As the Fed pumped money into the economy during the pandemic and recovery, speculation crept in. For some it seemed more like a casino than the disciplined, prudent process it should be.

The financial media was abuzz with cryptocurrencies and SPACs (blank-check companies often with questionable structures and reporting). There were also wild swings in initial public offerings and “meme stocks” – shares of companies in hot sectors touted on social media.

Many of the speculators did not fare well. One of the leading cryptocurrencies was down about 60% in 2022 and has lost roughly 70% since November 2021. That at least is better than some crypto assets that went to zero. As for SPACs, the CNBC Post Deal SPAC Index is down over 50% in 2022.

Our approach embraces change and innovation, as they are vital to growth of the economy and wealth. We also understand the capital we manage for our clients often came with great effort and sacrifice, so investments should be approached with thought and some degree of skepticism. We take no comfort in the losses of others. It does, however, reinforce our belief in restraint in both surging and declining markets.

Reason in the face of uncertainty; things can change quickly

There have been many reports in the financial media pointing out the declines of 2022. In many cases they are quite true. Others are often distorted and fail to tell the rest of the story. The day following the end of the second quarter, the Wall Street Journal ran the headline, “Markets Post Worst First Half of Year in Decades.” The statistic is correct. The specific year was 1970, so over 50 years ago. What the headline did not reveal was that after suffering a 21% loss in the first half of 1970, markets abruptly reversed and gained over 26% in the second half, managing a slight gain for the calendar year. You can’t make this stuff up.

 

The road ahead

We are neither pessimists nor optimists. We are realists. We acknowledge the difficulties faced by the markets in the first half of 2022. The war in Ukraine unfortunately continues. Inflation, so far, has shown few signs of abating. There is possibility of a recession. While we have been through many difficult and uncertain periods, there could be more challenges ahead. That is just the nature of investing.

There are reasons for encouragement. Even though there has been some pain, it is encouraging to see central bankers take the threat of inflation seriously. With the rise in yields, there is a greater likelihood that in the years ahead, bonds will contribute a more reasonable return.  As speculation has been wrung out of markets and valuations have come down, the opportunity for future gains has increased.

There is more to our approach than just repeating “stay the course.” For stay the course to mean anything, it needs to have substance behind it. That means doing the math. It means knowing our clients’ personal situations and goals. Then, we design portfolios in anticipation of risk rather than in response to it. We have done that.

We appreciate the confidence you have placed in us. We are here and always ready to talk.

CRN-4833640-070622

Sources of data- Wall Street Journal, CNBC, FactSet, S&P Global, MSCI, Russell, Bloomberg, Federal Reserve, Vanguard, Barclays Aggregate. The performance of an unmanaged index is not indicative of the performance of any particular investment. It is not possible to invest directly in any index. Past performance is no guarantee of future results. This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. Three-year performance data is annualized. Bonds have fixed principal value and yield if held to maturity and the issuer does not enter into default. Bonds have inflation, credit, and interest rate risk. Treasury Inflation Protected Securities (TIPS) have principal values that grow with inflation if held to maturity. High-yield bonds (lower rated or junk bonds) experience higher volatility and increased credit risk when compared to other fixed-income investments. REITs are subject to real estate risks associated with operating and leasing properties. Additional risks include changes in economic conditions, interest rates, property values, and supply and demand, as well as possible environmental liabilities, zoning issues and natural disasters. Stocks can have fluctuating principal and returns based on changing market conditions. The prices of small company stocks generally are more volatile than those of large company stocks. International investing involves special risks not found in domestic investing, including political and social differences and currency fluctuations due to economic decisions. Investing in emerging markets can be riskier than investing in well-established foreign markets. The MSCI EAFE Index is designed to represent the performance of large and mid-cap securities across 21 developed markets, including countries in Europe, Australasia and the Far East, excluding the U.S. and Canada. The Russell 2500 Index measures the performance of the 2,500 smallest companies (19% of total capitalization) in the Russell 3000 index. The S&P 500 index measures the performance of 500 stocks generally considered representative of the overall market. The Wilshire REIT Index is designed to offer a market-based index that is more reflective of real estate held by pension funds  

 

Ron’s Market Minute  — ‘Certainties’ We Might Look Forward to in the Second Half of This Year. 

The investing world looks highly Uncertain these days.  It appears that investors are (understandably) concerned about earnings, the Fed, fiscal policy, inflation, economic growth, geo-political problems, and probably a host of other areas.  With those in mind, however, there might be two relatively certain strategies, and these are central to our current portfolio positions.  They are one,  that the Fed will continue to tighten, and two, that corporate profits will continue to decelerate.  Given the choices between the Fed loosening or tightening, and profits accelerating or decelerating, I suspect that most of you would pick the combo that the Fed will tighten and corporate profits will decelerate. 

So, some statistics: Periods of Fed tightening have generally not been kind to markets.  Historically (since 1971) periods of Fed tightening have about a 20% chance of loss in the markets. When we add in time periods in which corporate profits are have receded, (we have both Fed tightening and negative corporate profits) the percent chance of a loss in markets (represented by the S&P Index*) rises to an historic 43% probability of a loss in markets. 

An historical real Fed Funds rate that is negative (for example, an inflation rate of say 8%, minus a Fed rate of say 1.5% = nets out to a real rate of about a minus 6.5%.) implies to economists that the Fed may have more trouble fighting inflation than expected. It also suggests that the fed, which normally lags the economy, may be forced to increase the rates even in the face of slowing corporate profits in order to meet the goal of maintaining price stability. 

Because inflation is a lagging indicator, we have been overweight traditional late-cycle sectors like energy and commodities. We continue to be fans of energy and like its long-term prospects. However, as profits decelerate, I suspect we will be leaning more into traditional defensive sectors such as Consumer Staples, Healthcare and Utilities. Our portfolios shift over time to reflect the global economy. The current disruption leads us to look at Staples at this time. 

And our overall position, based on the technical indicators, continues to be one of ‘very hedged’.  We (like you, I suspect) continue to hope that each small bounce is a potential door to the upswing we’d like to see. We remind you that a typical bear market has a number of bounces or head-fakes. Chances are good we’ll see a few more of these before Ms Market does the about face we’re hoping for and continues to move in the ‘Up’ direction. 

It continues to be a time for caution and patience.  (Statistics courtesy RB Advisors)  

Ronald P. Denk, CFP®
Investment Advisor
Denk Strategic Wealth Partners
10000 N. 31st Avenue, Suite D406A
Phoenix, AZ 85051
Phone (602) 252-8700
Fax (602) 252-8701
Toll-Free (877) The-Denk
www.denkinvest.com

LFS-4838570-070822

This weekly article reflects news, commentary, opinions, viewpoints, analyses, and other information developed by Denk Strategic Wealth Partners for use with advisory clients only and/or select but unaffiliated third parties. DSWP provides Market Information for illustrative and informational purposes only. If you wish to receive this weekly commentary by email, please contact us at 602-252-8700 or by e-mail at lindaw@denkinvest.com. If you are receiving this commentary via email and would prefer not to please let us know either by email or phone.

Ronald Denk is an Advisory Representative offering services through Denk Strategic Wealth Partners, A Registered Investment Advisor. He is also a Registered Representative, offering investments through Lincoln Financial Securities Corporation, Member FINRA/SIPC.

Denk Strategic Wealth Partners is not affiliated with Lincoln Financial Securities Corporation. Information in this commentary is the sole opinion of Denk Strategic Wealth Partners. Past performance is no guarantee of future returns. All market related investments involve various types of risk, which include but are not restricted to, credit risk, interest rate risk, volatility, going concern risk, and market risk.

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*The indices are representative of domestic markets and include the average performance of groups of widely held common stocks. Individuals cannot invest directly in any index and unlike investments, indices do not incur management fees, charges, or expenses, therefore specific index returns will be higher. Past performance is not indicative of future results.

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Past performance is not a guarantee of future returns.