Perspectives - Midway into the Current Down Cycle
We are in the midst of a difficult and complex cycle. Inflation is rising and asset values are falling. We can’t know how long it will last. But it’s important to realize that difficult and complex cycles in the past have ended with the cooling of inflation and price recovery for assets. So while today’s climate does warrant awareness and caution, we can also look for opportunity on the horizon.
Investors would have to dig up their great great grandparents’ journals to find a worse bond market than that which has occurred in the first half of 2022. High-quality investment-grade bonds declined by -17%; their worst price decline since the 1800s. Stocks did not fare much better. The S&P 500 dropped -20.5% and the Nasdaq 100 declined -29.5% in the first half of 2022. Overall, stocks have fallen by more than -23% from their highs in December.
Additionally, a 60-40 portfolio, largely recognized as one of the most common allocations between stocks and bonds, is down -17.8% so far in 2022. That is far worse than the 2008 Global Financial Crisis, and the worst start to a year since 1976. In fact, it ranks as the third worst in history, behind only the 1932 and 1933 Great Depression years.
Right now, the Federal Reserve is acting aggressively to fight inflation. Where we are in the cycle is anyone’s guess, but with the Fed willing to raise rates quickly and in rather large moves, we can presume that recession is a possible outcome.
So this is where we are. Has it been bad? Yes. How long will it stay bad? No one knows for certain. But what we can do is consider history and start looking ahead for opportunity.
Perhaps the best observation when looking at the history of equity markets is that declines always come to an end. Then prices reach a bottom and a new economic cycle starts.
Read that again. Often, stocks bottom out before the economy recovers. This implies that investors who buy while news headlines are terrible create great long-term opportunities for themselves.
Stock price movement is based on human emotion and sentiment in the short run, and tends to react quickly and violently to anticipated economic events. Since 1945, stocks have declined between -20% and -40% on nine occasions. On average, those declines occurred over 10 months and the recovery time was 28 months.
Where we are today
Today’s stocks are already pricing a recession in. And with a recession comes lower yields in the longer-dated bond market. This means that bond prices may have already experienced most of the total decline in this current cycle. In fact, some portions of the bond market are now offering good income for portfolios. And using history as a guide, if we do enter an official recession, stocks will have posted much of their losses.
As for the 60-40 portfolio, the worst 10-year return is +19% (no, that is not a typo - the worst return is still +19%), and that was if an investor bought in 1928 right before the 1929 crash and endured a decade of economic depression. There has never been a 10-year period where a diversified 60-40 portfolio declined.
Every equity market decline in history has rallied off a short-term low, and has always gone on to new all-time highs. Sometimes within a year, sometimes longer, but every bear market has ultimately been succeeded by a new all-time high.
Right now, investors can be doing the following:
1) Review their annual living expenses and making sure they have 12-18 months of cash for daily living set aside from their long-term portfolios.
2) Look for opportunities to come in the near future. And come they will, because in the long run, earnings and profitability and growth always win.
4) Review budget spending
5) Look at tax loss or tax matching strategies within taxable assets