Investment markets have continued to face a rough ride in 2022. In the first couple of months, equity markets dropped into correction territory. That is a decline of over 10% from previous highs. In March, markets trimmed losses on hopes the worst was behind us. The recovery was short-lived as markets again declined in the face of the triple threat of inflation, rising interest rates and the war in Ukraine. As we closed out April, many equity indices have returned to previous year-to-date lows.
Perspective on market declines
Frequent and meaningful communication with our clients is part of our process, particularly during difficult markets. The three previous calendar years were great for equity investors. Over that period, the S&P 500 roughly doubled in value. While rewarding, the returns were not easy. We had to navigate the pandemic as well as other concerns with discipline and restraint. It is difficult to watch these gains, even partially, erode. But periodic market declines are part of investing. Since 1928, a 10% decline has occurred, on average, about every 19 months.
This time, we are hearing that the decline feels different from some of the others we have been through. We agree. The pandemic-related decline of the spring of 2020 was quick and event-driven. The bulk of the brutal 34% decline lasted less than a month. This decline feels different because it has been slower and grinding. The NASDAQ Composite, home to many big tech stocks, peaked in November of 2021 and has fallen into bear market territory (a decline of 20% or more).1 The S&P 500 peaked in early January of 2022.2 Since then, the optimism over vaccines and recovery has been replaced by a litany of systemic and event-driven concerns; supply chain disruptions, inflation, rising interest rates and the invasion of Ukraine.
Another difference between this and the previous decline is the relative absence of safe havens. During the pandemic sell-off, as risk assets like stocks dropped, lower risk assets, like bonds, particularly Treasuries, held firm and even rose, providing stability to portfolios. During market history, it is common for bonds to show strength in years where the equity markets decline. Not this time. The Fed has made it very clear that they will be vigilant in efforts to tamp down inflation. That likely means more and faster interest rate increases. Broad bond indices have fallen along with stocks. When we turn to the fixed-income portion of our portfolio this time, we see declines as well. There is, however, a potential bright side to the bond declines. As bond prices decrease, the prospect for higher streams of income in the years to come increases.
How to get through them
We know all the historical facts and figures about the regularity of market declines, while true, are not all that comforting when looking at your investment statements. While declines occur for lots of reasons and have different durations and in varying magnitudes, it is the long-term effect on investors that matters. These effects fall into two groups. The first kind of decline is associated with the normal course of market movements. We are not dismissive of them. They can be painful and frustrating but unavoidable if one hopes to grow their purchasing power over time.
The second, and most dangerous type of portfolio decline, is “the permanent loss of capital.” This type of decline should be avoided if at all possible. While you won’t likely hear this phrase on CNBC or social media stock boards, it is over 100 years old. It is often attributed to noted U.K. 19th century economist and former endowment portfolio manager of King’s College, Cambridge, John Maynard Keynes. Dedicated followers include Benjamin Graham and Charlie Munger. It has long been a core concept of our firm as well. Mr. Buffet even alluded to this principle at the Berkshire annual meeting this past weekend when he lamented that many had turned away from sound principles and turned to a “casino-like” mentality. During the lockdown speculation craze, the battle cry was often, YOLO; “you only live once.” Taking outsized, often highly risky, leveraged bets was a popular choice for some. This approach has probably resulted in a permanent loss of capital for many. Similarly, trendy growth IPOs with no present earnings and SPACs have experienced large losses. We agree that we “only live once,” but that just strengthens our resolve to be good stewards of wealth.
We all know attempting to predict short-term market movement is difficult, and there are no guarantees. There are, however, things that we can do. We accept that investment markets are both risky and unpredictable. Portfolios should be mathematically built with that in mind. We try to avoid speculation and leverage. In our opinion, the end goal is not to outperform an index or your brother-in-law’s meme stock trades. The goal, as in the pandemic decline and today, is to weather the inevitable downturns and live to fight another day. That is what matters.
We use diversification, risk tolerance, Monte Carlo and efficient frontier analysis and other mathematical tools to help. While you may not care to hear an hour-long explanation of these tools, many clients are glad to know they are there. Remember that we are here; during the good times and the not-so-great times. Let us know if you would like to talk things over.
1The NASDAQ Composite is an unmanaged index of securities traded on the NASDAQ system.
2The S&P 500 consists of 500 stocks chosen for market size, liquidity, and industry group representation. It is a market value weighted index with each stock’s weight in the index proportionate to its market value.
Sources: S&P Global, Dow Jones Indices, Forbes, CNBC, Morningstar, NASDAQ, Barclays, Reddit, Lincoln Financial Advisors. Diversification may help reduce, but cannot eliminate, risk of investment losses. Historical performance relative to risk and return points to, but does not guarantee, the same relationship for future performance. There is no assurance that by assuming more risk, you are guaranteed to achieve better results. Past performance is not indicative of future results.
Ron’s Market Minute – Was There a Rally this Week?
Wow- a lot of fireworks in markets this week. As usual, in the week of a Fed meeting, we prefer to stay away from trading because of potential market distortions. And then (also as usual) in the late hours of the market on Wednesday (Fed announcement day), we had a reaction. An incredible reaction, we thought, as markets soared to the upside. Then, yesterday (also per normal) markets had a counteraction and gave back all the gains from Wednesday, and then some! To keep things short, we will not discuss the ‘whys’ but rather address the question ‘Did anything change?’ Have a look at today’s graph. It shows the returns information of Value stocks in Red; vs returns of Growth stocks in Green since the first of this year. We are using the ETF VTV to represent the value stocks, and VUG to represent the growth stocks.
Quite the contrast. If you have held only Value stocks (red) this year you are down- but not much. As of last night, you were down about 2.5%. Hardly a concern. On the other hand, if you had stayed with the growth stocks (green) which have been the big winner for last year, (and for that matter, also the winner for the past decade!) you have quite a different result. So far this year you would be down about 22%. No matter how you slice it, growth stocks are in a bear market. Perhaps more important, have a look at the lower half of the chart which shows the RELATIVE strength of the value stocks vs the growth stocks. The grey line moves from lower left to upper right of the screen, indicating not only that the value stocks are stronger today but that they are becoming Stronger vs the growth stocks!
Historically, investors tend to stay with what works or what has been working for them. This year, that means that the bulk of the invested dollars are still living in a growth stock environment. While we cannot predict the future, other than to say that things will change, I think it is safe to say that at this time, value-oriented stocks are a better place to be. If you have held half and half (growth and value) you are only down around 10-12%- better, but as I said, Value appears to be a better place to be. For now.
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
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 firstname.lastname@example.org. 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.
The Update provides information of a general nature regarding legislative or other developments. None of the information contained herein is intended as legal advice or opinions relative to specific matters, facts, situations, or issues. Additional facts, information or future developments may affect the subjects addressed in this document. You should consult with an attorney, accountant or DSWP planner about your particular circumstances before acting on any of this information because it may not be applicable to your situation.
Lincoln Financial Securities and Denk Strategic Wealth Partners and their representatives do not offer tax advice. Please see your tax professional regarding your individual needs.
*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.
Please see Denk Strategic Wealth Partners’ Client Relationship Summary here http://denkinvest.com/?page_id=7099 for succinct information about the relationships and services DSWP offers to retail investors, related fees and costs, specified conflicts of interest, standards of conduct, and disciplinary history, among other matters.
LFS’ Regulation Best Interest Disclosure Document, which describes LFS’ broker-dealer services, and other client disclosure documents can be found here <https://www.lfg.com/public/lincolnfinancialsecurities/clientinformation/overview/disclosure>.
Past performance is not a guarantee of future returns.