Well, 2022 has started off with a bang but not in a great way. As I type this, stocks (S&P 500) are down around (13%) YTD but what many people don’t realize is that bonds / fixed income (AGG) is down around (10%) YTD (more on this to come below.) We began the year dealing with inflation and rising interest rates and FED policy change (less loose but not tight yet) and then the Russia / Ukraine war exacerbated inflation pressures and the supply chain disruptions caused by the Covid lockdowns and further delaying the FED from acting on interest rates. The market doesn’t like uncertainty and this added to the uncertainty. However, almost 5 months into the year and right at 60 days from the invasion, the market “knows” about most of the things people are worrying about. Considering the strong market results the past decade and the historic rebound off the market lows of Covid (March 23, 2020), the market is holding up pretty well and has “so far” acted more like a normal correction that historically occurs every 2-3 years.
So, where do we go from here….? We have been in numerous meetings and conference calls with many of our different professional partners digesting the data and gauging various outlooks. See below for some quick thoughts:
- Fixed income / bonds: We have been talking about this for over a year now how bonds would / could struggle with interest rate increases. Most of the damage has probably already been done (with the AGG being down (~10% YTD) but bonds will very likely print losses on the year and not able to provide much upside return. Couple that with inflation that could stick around a few years and it is a very challenging environment for bonds and conservative investors overall.
- Alternatives to traditional fixed income: We implemented some of these holdings (strategic income, floating rate, commodities, and other alternatives) to help fight the rise in interest rates and they have done their job and held up a little better during this challenging environment.
- Bullish case for stocks:
- Normal correction: As we alluded to earlier, the market historically corrects 10-15% every 2-3 years and “so far” we have fallen within those norms and even re-tested certain indicators a couple of times.
- Investor sentiment: Historically, when the average investor is bearish, it is time to buy. Just recently, the AAII bullish indicator was down to only 15.8%, which is lower than what we saw during the 2008 financial crisis! Since 1988, bullish investor sentiment has dipped below 20% 36 times and EVERY time (with the exception of 2008), the market was higher 6 month later with an average of 12.6% and 12 months later at 19.8%. We just may look back a year from now and wish we bought more (or stayed invested at least.)
- Bonds: As the world is evaluating their bond exposure with the recent selloff, and outlook for fixed income in the coming years, stocks may continue to benefit from flows out of bonds.
- Fundamentals: Company earnings and economic growth was expected to grow in 2022, albeit at a slower pace from 2021 as companies and the economy benefitted from the world re-opening. Despite a negative Q1 (1.4), there were bright spots such as consumer spending, business development, and home building. In addition, the increase in imports has had a big role in the GDP drop. So while sobering to see the negative number in Q1, it may be more positive than it looks.
- Many stocks are down much more than the broad markets: As we have written about in the past year, under the surface, many of the stocks within the broad indexes are down much more than what the index shows. For example, many of the stocks within the Nasdaq are still down around (50%), potentially providing upside opportunity. In 2021, if you took out just the top 10 performing stocks of the S & P 500, the market returned just ~5%. Since there has been a lot of volatility and rotation of leadership under the surface, this could provide fuel for more upside when some of the fears subside (inflation shows signs of cooling, Russia / Ukraine easing)
- Technology / innovation: Longer-term, when you look at some of the technologies and innovation down the pipeline, it could suggest that we still have years left to run, albeit with corrections along the way. During the 1980’s and 1990’s bull run that lasted almost 20 years, there were certainly bumps in the road (recession of 1980/1981, crash of 1987, savings and loan crisis of the late 80’s, 1990 / 1991 recession)
- Bearish case for stocks:
- Inflation: Inflation could continue to run much hotter, which would eventually put pressure on consumers, companies, and the economy. While we feel it will remain more elevated than previous years for some time (a couple of years or more) the pace of increase hopefully will slow in the back half of 2022 / early 2023. Again, you can’t shut down the global economy and flood trillions of dollars into the system and not expect consequences.
- FED policy: The FED is behind the curve on raising interest rates and is now dealing with inflation not seen in 40 years and we run the risk of them raising rates too far, too fast, essentially throwing a wet blanket on the economy.
- Geo-political events: These are difficult to predict but as we wrote about earlier this year, after the initial invasion and volatility in the markets, the rebound usually spikes soon after and is normally higher just months later. Of course, those that fear the worst-case scenarios usually don’t happen and are impossible to predict.
- Economic Growth challenges: Coming off the re-opening of the economy from Covid, the economy saw record growth (after record contraction). The economy can’t keep up the same pace as the re-opening numbers and so we’ll see slower growth (or another contraction).
Ultimately, we lean towards the bullish case. Regardless of which outcome occurs, we have taken steps to try and find the bright spots, along with better protection outside of the traditional places. Things change rapidly these days but history offers valuable lessons, easily and often forgotten. As long as uncertainty persists, so will the volatility.
Jeremy & Eric