Our colleagues at Lincoln Financial issued a commentary piece that we found quite interesting –enough so, that we’re passing it along to you:
After three years of powerful returns, investors entered 2022 hoping for more of the same. That was not the case. There were several reasons. Inflation, fueled by supply chain disruptions and pent-up demand, continued to surge. Although at least part of the rise in inflation is likely temporary, inflation rose at the highest rate in decades.
The Fed, which had slashed short-term interest rates to near zero in response to the pandemic, took note. It signaled that for the first time since 2018, it was poised to increase interest rates multiple times to help quell inflation.
While investors grappled with these twin threats, another was building. Russia, which had coveted neighboring Ukraine’s prosperity and strategic location on the Black Sea, began amassing troops and weaponry at the Ukrainian border. Then, in late February, Russia mounted a comprehensive invasion. As Russia is a major energy exporter, oil prices spiked. This further complicated the inflation and interest rate picture.
Markets struggled throughout the first few weeks of the quarter but given this triple threat, it was more than some could bear. By early March, the DJIA and the S&P 500 had both entered a “correction,” which is a decline of 10% or greater. The Nasdaq Composite, the darling of 2020 and 2021, had passed into a “bear market,” with a decline of 20% from last year’s highs.
Most importantly, our thoughts are with those impacted by the war. Acknowledging their suffering and pain are vastly more important than markets and money. At least at this point, the people of Ukraine have proven far stronger than the invaders imagined, with many fighting house-to-house to defend their families and homeland. It is hard to imagine such courage, and our thoughts are with them.
There is an old market saying, “markets often do whatever it takes to confound the largest number of people.” That is what happened. Yes, inflation has continued to be stubbornly high. The Fed did raise interest rates in late February, as expected, and the war in Ukraine continues. Since the lows, however, equity markets staged a comeback trimming losses.
U.S. and International Equities: Given the events of the first quarter, stocks held up reasonably well. You would hardly know it from the financial news. A frontpage headline from the Wall Street Journal on April 1st proclaimed, “Stocks Suffer Worst Quarter in Two Years.” True, but it leaves out that the two years they reference were marked by a largely relentlessly rising market. Some always see the glass as half-empty.
As for U.S. equities, the S&P 500 ended the quarter down 4.6%, the lowest decline among the broader indices. U.S. Mid-caps dropped 7.5%. International equities didn’t fare as well as the S&P 500. This is likely because of Europe’s closer proximity to the conflict and dependence on energy imports from Russia. The Developed Market Index declined 5.9% for the quarter. Emerging markets also declined, giving back 7%.
Fixed-Income: Like stocks, bond prices benefited greatly from the Fed’s actions during the pandemic. As interest rates fell to near zero, bond prices rose. Eventually, with a recovering economy, things had to return to a more normal state. As it became more likely that the Fed would be more aggressive to fight inflation, bond prices dropped. Often U.S. bonds, particularly Treasuries, are a safe haven when a dramatic event like the Ukrainian invasion occurs. Even the flight to safety wasn’t enough to overcome the pressure from inflation and rising rates. The Barclays Aggregate, a measure of the broad bond market, fell 5.9% for the quarter.
Back to our half-filled glass, there can be a positive side to rising rates. Given the pandemic and before it, the Great Recession with its unusually long recovery, interest rates have been abnormally low for many years. For investors, it may be worth the pain of declines in the value of bond portfolios in exchange for more reasonable returns in the years to come.
This isn’t over. It never is.
We are not dismissive of any of the current issues affecting markets and your portfolio. We know they are real challenges, and they are not likely going away soon. When they are resolved, more will come behind them. That is just part of investing. We are realists. Our optimism doesn’t replace discipline, preparation, and resolve. It is strengthened by them.
Thank you for your trust and confidence. We are here if you need anything.
Ron’s Market Minute — A VERY Long Look at Treasury Yields
We’ve often said that people just don’t live long enough to see the bigger pictures in markets. As I’ve heard from some of you this week- and your concerns about inflation, I found myself looking at interest rate returns going back to the 1980’s. Based on your questions, it seems that many of you have forgotten what it’s like to live in a truly inflationary environment. And some of you were toddlers at that time!
A neighbor of ours (around the mid 80’s) was thrilled to get a mortgage at 12%. For comparison- the payment on a 12% mortgage is about two and
a half times (!) the payment on a 3% 30-year mortgage. Along with those scary numbers, think about car payments, and credit card payments based on (almost) unthinkable interest rates.
Have a look at today’s chart of 10-year treasury rates. The chart goes back to the early 80’s. Yield rates have gone incredibly steadily down since then — until recently. It’s been a nice world where we could own bonds and along with some diversification against stock holdings, bonds gave us a yield component. We actually earned returns on the bond holdings.
In addition to the recent headlines regarding high (6-8%) inflation, from a technical perspective the price charts are close to crossing the very long downtrend line. A break across the line would be significant- and give us a reasonable expectation that rates could be not transitory, but also perhaps much higher than we’ve been thinking.
Since the beginning of this year, it’s been more than difficult to work within the bond world- for investors. Year-to-date the general bond market is down about minus 6%- talk about investor shock! We’ve had to look in less common places for bond (and bond-like) holdings.
This may be just a taste of the future of portfolio changes. We expect more to come.
Now remember that the Fed has only ONE bullet in it’s arsenal: that is to ‘raise rates’ to ‘fight inflation’. That said, not too long ago when markets reacted negatively to FED actions, the Fed threw in the towel and brought us back to near-zero rates. Will it happen again? Or will they stand the ground and continue the fight?
Ronald P. Denk, CFP®
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
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