Almost halfway through 2022, we’ve seen significant losses in both stocks and bonds. As of May 13th, global stocks were down 16% and global bonds were down 12%. Higher interest rates, the war in Ukraine, and persistent inflation have left very few asset classes safe from the sell-off, and while bonds typically provide stability when equities are down, a benchmark 60/40 stock-bond portfolio is down over 14% year-to-date. Edward McQuarrie, an emeritus professor of business at Santa Clara University, said in a recent Wall Street Journal article, “The broad bond market has performed worse so far in 2022…than in any complete year since 1792 except one. That was all the way back in 1842…”
Why the Volatility?
The Fed’s approach to tackling inflation through interest rate increases and the signaled reduction in their balance sheet by a pace of $1T annually is intended to stamp out inflation while trying not to cut the legs out from under the economy. However, the most recent interest rate increases aren’t the reason for the volatility. Instead, it is the changing expectations around just how strong inflation numbers are.
This time last year, the market was pricing in zero rate hikes for 2022 and 2023. Just six months ago, it shifted to pricing in one hike for 2022 and three for 2023. Today, the market is pricing in seven hikes this year alone, including three sequential 50 basis point moves (May, June, and July) and the Fed Funds Rate ultimately rising from zero to 3.5% between the fourth quarters of 2021 and 2023, respectively. In addition, the markets are rapidly repricing assets and factoring in the potential for a recession.
What’s the Plan?
We consistently advocate for short-term cash reserves for clients in a distribution equal to 12-18 months of cash needed. In poor market conditions, these reserves may be utilized so longer-term assets can be held or positioned for future value two to three years down the road. Now is the time to use safe funds that are not part of your long-term portfolio allocations, as the markets may take a number of months to find their new equilibrium.
With respect to bonds, we do think a majority of the rate increases have been priced into current markets, especially under a recessionary scenario. However, the conflict in Eastern Europe and lockdowns in China could further fan the flames of inflation beyond the Fed’s control.
Consumer sentiment has fallen to a new 11-year low, as persistent inflation and weakness in equity markets are likely hurting confidence. However, following eight previous lows in consumer sentiment over the last 50 years, subsequent 12-month S&P 500 returns averaged almost 25%. This illustrates that selling longer-term equities when feeling the worst is not the best investing decision.
As always, no one can be certain about the timing of market events. Sticking with discipline to long-term plans will likely yield a much higher probability of success.
“The most common cause of low prices is pessimism—sometimes pervasive, sometimes specific to a company or industry. We want to do business in such an environment, not because we like pessimism but because we like the prices it produces. It’s optimism that is the enemy of the rational buyer." Warren Buffet
*The foregoing content reflects the opinions of Van Hulzen Asset Management DBA "Van Hulzen Financial Advisors" and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. Securities investing involves risk, including the potential for loss of principal. There is no assurance that any investment plan or strategy will be successful.