(Today’s eLetter contains content from Lincoln Financial Services.)
Investment markets during the third quarter continued a volatile course, with frequent advances and sudden reversals. In the early part of the quarter, investors had hoped that the Fed’s interest rate hikes had done their job and the speed and size of the increases would subside. A summer rally ensued with both equity and fixed-income markets mounting powerful rallies. The S&P 500 cut its first six months declines in half, and the Barclays Bond Aggregate erased a third of its decline.
Unfortunately, the mid-summer gains would not hold. As inflation reports came in even stronger than some expected, investors faced the Fed reiterating their hawkish statements to battle inflation with continued rate increases even if that resulted in “some pain” to the economy. With the realization that a resolution to the inflation problem would take longer to resolve than some expected, markets reversed course yet again.
By the end of the quarter, stocks declined to the second quarter lows. The S&P 500 ended down 4.9% for the quarter and was down 23.9% for the year-to-date. There was little in the way of safe havens. Smaller U.S. stocks, represented by the Russell 2000 index, fell 2.2% for the quarter and lost 25.1% for calendar 2022. The performance of international stocks was even more challenged, due to the uncertainties of the Ukraine war and heightened concerns around energy availability, international stocks lost significant ground. The MSCI EAFE International Index dropped 9.4% for the quarter and has slumped 27.2% year-to-date.
Bonds usually benefit from a “flight to safety” in times of equity declines. With an aggressive Fed threatening higher rates, this was not to be. As with equities, as hopes for a quick resolution to the inflation problem faded, bonds continued their slide. At quarter end, the bond index dropped 4.8% for the quarter and has fallen 14.6% for the year.
As we have noted before, the rise in bond yields has a potential silver lining. Keep in mind that interest rates and bond prices generally move inversely to each other. As bond prices have fallen, adding to portfolio declines, yields have risen considerably. While painful today, it bodes well for bond returns in the future.
Bear market perspectives
Market declines are, at best, unpleasant. We understand. These assets took years of effort and sacrifice to accumulate. Even the most seasoned investors can be unsettled watching their hard-fought gains erode. But it can be helpful to look more closely at market declines to gain some perspective.
A bear market is usually defined by a decline from recent highs of 20% or more. So, yes, we are there. Keep in mind that declines of this magnitude are not uncommon. Since 1945, there have been 15 of them. So, one has occurred about every 5 years. They are painful and not fun, but they have passed.
Now, to the length of bear markets. The average length of a bear market, that is the number of days from the time the index falls 20% until the time it regains its previous level, is 289 days. That is a bit over nine months. While shorter than many might have thought, it is still no picnic.
On the other hand, let’s look at the average length of a bull market. That comes in at a whopping 2.7 years. Of course, these are just historical averages and there could, as always, be large variances from the norm. But we find this data encouraging for long-term investors. Simply put, despite painful intermittent declines, markets have historically marched forward.
The path forward
While we have been through declines before, they are never easy. Shrill voices come out of the woodwork. The financial media is always there with dire forecasts of worst-case scenarios. Warren Buffett, who has seen more bear markets than most once said, “Forecasts can tell you a lot about the forecaster but nothing about the future.” Media get paid by the number of viewers- not for accuracy. As we have said many times over the years, financial decisions are best made with the television turned off.
The volatility is not likely over. Markets must still work through the distortions brought on by monetary response to the pandemic. The Fed likely will continue to target inflation. The uncertainty of the Ukraine war is not over.
That’s ok. We can handle these challenges. We believe markets and, more importantly, people, are far more resilient than many understand. We will stand firmly on our principles of discipline, restraint and sound mathematics. Of course, your input is important to our process and our path forward. We are here.
(Sources: Hartford Funds, Forbes, CNBC, S&P Global, Wall Street Journal)
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 CRN-4979886-100422
Ron’s Market Minute — What Happened in the UK?
What do we know? Most central banks are fighting a balancing act between challenging the current robust inflation and NOT triggering a huge downturn in economic activity. In other words, they are trying to do what they can towards finding a ‘soft landing’. That’s a noble goal and we wish them luck because the alternative to a soft-landing is a crash landing.
Now, things don’t always turn out to meet expectations and if you are a central banker, this is something you know all too well. Nevertheless, central bankers are often under the influence of government, which is run by politicians and not economists. Thus, the potential for surprises, and mistakes is magnified. A case in point is the Bank of England. At the very end of September the BOE felt the need to step in and ‘stabilize’ its capital markets and pension system. This injection of ‘stability’ was a response to a ‘Disturbance in the Force’ caused by a round of margin calls. The strategy they applied was the purchase of bonds (Gilts, in Britain). The Bank of England is authorized to do this without further government approval because it’s already in their charter. However, a rather embarrassing situation quickly unfolded because the new government of Liz Truss was announcing a new round of tax cuts. Maybe our good friends across the pond were distracted by the passing of their beloved Queen but, whatever the reason, the policy people had lost the plot – the plot being to reduce inflation. You see, both the bond-buying and the tax cuts are stimulative moves — meaning they would tend to PROMOTE inflation at the same time as central banks worldwide are trying to REDUCE inflation.
In the US by comparison, the Fed announced that it has yet to wind down any of the balance sheet securities as they had announced earlier though it is definitely in an inflation-fighting mood — a rare moment of sense-making in Washington.
From afar, the UK’s action appears to be odd behavior. The well-respected American economists Larry Summers commented that it appeared that the UK was now a ‘submerging market’. Ouch!
And speaking of odd behavior, on Monday and Tuesday the US markets apparently took this as a signal that the inflation FIGHTING might be coming to an end. Markets jumped and kept going up on Monday and Tuesday (although I believe this was primarily caused by a mass selling of shorts). In any event, it appears that (as of Thursday afternoon) markets have reverted to at least a stabile position – with the possible exception of the Energy sector. Or perhaps they are just in the process of continuing their current longer-term downswing. Time will tell.
History shows September is generally a weak month in financial markets. (October is normally also weak but not as weak as September.) Perhaps the strange-looking US market behavior was merely related to where some things fell/are falling on the calendar. The calendar history suggests that October months in a mid-year election tend to turn upward. Guess we’ll see. We have begun to dip into the energy markets once again, but mostly remain very conservatively positioned. These are volatile and dangerous markets.
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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