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Q3 2022 Market Commentary: Zoom Out

Just when it looked like stocks might be bouncing back from a dismal first half of the year, everything turned negative again. As this chart from Morningstar shows, stocks were up almost 15% at one point in the third quarter, only to finish September back in the red. Almost every category of stocks fell in the quarter, with large-cap US stocks down 5%, small-cap US stocks down 2%, international developed market stocks down 9%, and international emerging markets stocks down 10%. 

Continuing a trend from the first half of the year, interest rates also rose in the quarter, pushing bond returns further negative on the year. US core bonds were down about 5% on the quarter, while longer-term bonds fell even further. The yield on two-year US treasuries ended the quarter at 4.22%, the highest they’ve been since October 2007.

Most alternative asset classes also struggled in the third quarter, as REITs were down 11%, commodities were down 4%, and Gold was down 8%. The only asset classes that posted positive returns in the quarter were MLPs, oil and gas stocks, and managed futures.

This poor performance in the third quarter means that 2022 is shaping up to be a historically bad year in the markets. The 10-year Treasury bond is on pace for its worst year ever, and we are in the midst of the longest and deepest drawdown we’ve ever seen in the US bond market. Even a diversified 60/40 portfolio is down over 20%, also on pace for one of its worst years ever!

The next chart shouldn’t come as a surprise, given all the figures I outlined above. The AAII Sentiment Survey shows near-record levels of pessimism vs. optimism among investors. The only other times we’ve seen investors so bearish were in October 1990 and March 2009. This type of extreme bearish sentiment has historically been a positive indicator for future returns. The average forward total returns of the S&P 500 over all periods are positive when we’ve seen extreme fear readings like this in the past. 


This data dovetails nicely with this graphic we often share from Carl Richards, author of the Behavior Gap. The last time we shared this image in a market commentary was the 3rd quarter of 2017, at a time when stocks were up double digits across the board. You can see in the AAII chart above that investor sentiment was very bullish at the time. We warned clients in that article to enjoy the good times but to be prepared for the tide to eventually turn the other way, as it always does. We told you that our job is to keep you from making the wrong decision at the wrong time, and now that we’re on the fear/sell side of the chart, that’s exactly what we are here to do! 

We understand and feel the same emotions you are likely feeling right now. While we believe in the long-term benefits of staying invested and not trying to time the markets, that doesn’t mean we are immune from feeling fear. When we watch both stocks and bonds fall in value day after day, we have the same gut reaction of wanting to sell and sit in cash. We had the same feeling in March 2020 and December 2018, and many other times, we’ve had to sit down with clients to tell them about the losses in their portfolios. We see it in our own portfolios as well, which are invested the same way we advise clients to invest their portfolios. It’s natural to feel these emotions and to be scared at times like this, but it’s important not to overreact and hurt yourself in the long run. 

So how do we get past these emotions and not give in to the desire to take action? We try our best to detach ourselves from these emotions and look at the situation from a different point of view. We zoom out and remind ourselves not to get so wrapped up in the short term. We look back in history and realize something like this has happened before, probably many times!

Zoom Out

We constantly tell clients to focus on the long term, yet we all live in the short term. It’s incredibly difficult to focus on long-term returns when we are bombarded with news about what the market is doing today and what might happen tomorrow. Everyone wants to know what the Fed will do at their next meeting and what next month’s inflation reading will be. Nobody talks about where rates might be 5 years from now or what inflation might look like in 10 years, but if you have an appropriate financial plan in place, the long-term is all that matters. If you are still in savings mode and putting money away for retirement, a market downturn is an excellent buying opportunity for you. If you are in retirement and drawing down on your portfolio, you should have enough in cash and conservative investments to cover your short-term needs, so the rest of your portfolio has time to recover. And for those of you in retirement, the higher interest rates that drove down the price of your bonds will mean much higher income from that portion of your portfolio in the future.

Famed investor Howard Marks talked about short-termism in a recent memo, and I think it is worth a read for every investor:

          All the discussion surrounding inflation, rates, and recession falls under the same heading: the short term.  And yet:

  • We can’t know much about the short-term future (or, I should say, we can’t dependably know more than the consensus).
  • If we have an opinion about the short term, we can’t (or shouldn’t) have much confidence in it.
  • If we reach a conclusion, there’s not much we can do about it – most investors can’t and won’t meaningfully revamp their portfolios based on such opinions.
  • We really shouldn’t care about the short term – after all, we’re investors, not traders. 

I think it’s the last point that matters most. The question is whether you agree or not. 

For example, when asked whether we’re heading toward a recession, my usual answer is that whenever we’re not in a recession, we’re heading toward one. The question is when. I believe we’ll always have cycles, which means recessions and recoveries will always lie ahead. Does the fact that there’s a recession ahead mean we should reduce our investments or alter our portfolio allocation? I don’t think so. Since 1920, there have been 17 recessions as well as one Great Depression, a World War and several smaller wars, multiple periods of worry about global cataclysm, and now a pandemic. And yet, as I mentioned in my January memo, Selling Out, the S&P 500 has returned about 10.5% a year on average over that century-plus. Would investors have improved their performance by getting in and out of the market to avoid those problem spots . . . or would doing so have diminished it? Ever since I quoted Bill Miller in that memo, I’ve been impressed by his formulation that “it’s time, not timing” that leads to real wealth accumulation. Thus, most investors would be better off ignoring short-term considerations if they want to enjoy the benefits of long-term compounding.

Remember Your History

Whenever we see losses as we have seen so far this year, we naturally start to worry that “this time is different”. There is no shortage of evidence that we are living through a unique period in financial history. We’ve never seen inflation this high while rates are this low. We’ve never seen the Federal Reserve raising rates at the same time the stock market is collapsing. We’ve never seen GDP decline with the job market this strong. This is indeed a unique period in financial history, but that doesn’t mean we can’t apply anything from history to this period. 

It’s been said that history may not repeat itself, but it does rhyme. While we might not have been through these exact circumstances before, there have been many similar periods in our history. Morgan Housel recently wrote an excellent article about engaging with history. In it, he relays a story about an Ohio lawyer writing during the depths of the depression in 1932:

When writing his Great Depression diary he was struck by how similar the 1930s were to previous big recessions. “I have done considerable reading about the depressions of 1837 and 1873,” he wrote, “and I am amazed at the similarity to conditions today.”

A year later he researched the Depression of 1893 and wrote, “I am again struck by the similarity.” The way people responded to decline and how politicians behaved and how greed and fear controlled investment decisions seemed identical.

This is some of the most valuable economic information you can get your hands on. Of course Roth knew nothing about today’s technology or the war in Ukraine or where the S&P 500 will trade in 2023. But he knew economies have a long history of panic and sudden collapse, driven by a similar pattern of optimism leading to debt and debt leading to crash. And the fact that he recognized it 90 years ago and it’s still relevant today makes it critical information to learn from, because you know it foretells our future.

This year hasn’t been easy for any investor, and in the short term, things could get even worse. However, we still believe that staying invested in a diversified portfolio is the best way to achieve long-term financial success. If you struggle to control your emotions, take a few minutes to zoom out and look at your portfolio returns over the past 5 or 10 years or longer. Read a book about financial history and acknowledge that you aren’t the first person to feel this way. And as always, feel free to reach out to us to schedule a time to discuss your finances. We are here to help you make the right decisions for your financial future.

-Chris Benson, CPA, PFS

The views expressed represent the opinions of L.K. Benson & Company and are subject to change. These views are not intended as a forecast, a guarantee of future results, investment recommendation, or an offer to buy or sell any securities. The information provided is of a general nature and should not be construed as investment advice or to provide any investment, tax, financial or legal advice or service to any person. Please see Additional Disclosures more information.