After two years of strong returns in the markets, the poor results of 2022 should not come as a complete surprise. We know markets cannot go up forever and bear markets are unavoidable that occur on average about every four years. Unfortunately, no matter how normal they might be, bear markets are still painful to live through. Nobody enjoys seeing their hard-earned dollars decline in value and this year almost everyone has seen their portfolio value decline. Things have been bleak in the investment world this year, but it always helps to look for the silver lining. Let’s look at this year’s good, bad and ugly, but we’ll start with the ugly!
Technology stocks - After years of outperforming other stocks, technology stocks were hit the hardest in the first half of 2022 and many have been in a sharp decline for over a year. The NASDAQ was down 30% but many individual tech stocks suffered a sharper decline. Below is a chart showing some names everyone is familiar with, all of which are down over 50% this year.
Long-Term Bonds - When interest rates rise, bonds lose value as newer bonds issued with higher interest rates become more attractive. Long-term bonds are more sensitive to interest rate fluctuations because they are locked in at lower interest rates for a longer time. With rates rising in the first half of the year, long-term bonds accordingly saw the worst losses of 20% or more.
Cryptocurrencies - No asset class has crashed as hard as cryptocurrencies this year. If you felt the FOMO as the prices of many coins surged the past two years, you should no longer feel you missed out. Here is a chart showing the drawdowns of some of the bigger cryptocurrencies this year.
Inflation - I covered inflation in this article last month so I won’t spend much time on it here. However, this has been the worst bout of inflation we’ve seen since the 1970’s so it certainly belongs in the “ugly” category so far this year!
US Large Cap Stocks - We frequently use the S&P 500 as a broad measure of how US stocks are doing, and this was the worst first half of the year for the S&P 500 since 1970 with a decline of 20%. Below is a chart of first-half returns for the S&P 500 courtesy of Michael Batnick.
Other Stocks - Large-cap stocks are not alone as most other stock categories were also down in the second quarter and year-to-date. Small-cap stocks were down 23% on the year, developed market international stocks were down 19%, emerging market stocks were down 17% and REITs were down 19%.
Intermediate-Term Bonds - As noted above, long-term bonds suffered the worst losses from the rise in interest rates, but even intermediate-term bonds suffered significant losses with most down 8-10% on the year. In another chart from Batnick, we see that 10-year US Treasury bonds just had their worst first half since 1788!
Housing - Home prices exploded over the last couple of years, but the rise in interest rates might finally slow things down. Mortgage rates have jumped higher this year and combined with soaring house prices, housing affordability is worse than it has been since 2007.
Alternatives - There have been a few bright spots in the markets this year. Commodities were up about 19% for the first half of the year, though they have started to pull back in recent weeks. The Dow Jones Oil & Gas index was up about 30% on the year as oil prices rose. Some liquid alternative strategies did well in the first half, like Managed Futures, which were up around 12%. Gold was down about 1% on the year, which qualifies as “good” in 2022!
Interest Rates - Bonds might lose value initially when interest rates rise, but higher interest rates are good for investors in bonds over the long-run. The higher rates have also started to make their way to money market funds and high-yield savings accounts, where you can now earn more than 0% on your cash.
Valuations - The upside to any decline in the markets is that valuations become much more attractive, and that is certainly the case this year. The next chart from JP Morgan looks at the Forward P/E ratio as a valuation measure. You can see that we were well above the 25-year average to start the year but are now just under that long-term average. This doesn’t necessarily mean that stocks are “cheap” but they are much more attractive than they were at the start of the year.
Job market - While recession fears continue to dominate the headlines and there are some worrying signs in the economy, the job market is certainly not one of them. The unemployment rate remains historically low, and we continue to see more people joining the workforce.
What To Do now
Now that we have reviewed the past six months, here are a few things you should be considering right now:
Stop watching the market every day. We know it is impossible to completely tune out the news and what’s happening in the markets, but the less you check on your portfolio the better off you’ll be. Yes, the returns have been ugly so far this year, but use this next chart as a reminder to keep a long-term perspective. This shows the twenty worst six-month periods for the Wilshire 5000 over the past fifty years and what happened next. You can see that in all but one case, returns were positive after the next year and in all cases, returns were positive over the next three years.
Stay diversified. At first glance, diversification might not have worked the way you hoped this year, as both stocks and bonds are down. But what if you had invested only in tech stocks, long-term bonds, or cryptocurrencies? Diversification can help within asset classes even when correlations between asset classes are positive.
Do not try to time the markets. When markets are going down it can be very tempting to try to get out and wait for things to calm down before you get back in. Unfortunately, it is impossible to predict when things will turn around and being out of the market will severely impact your long-term returns, as you can see in this chart from DFA.
Take advantage of higher interest rates. If you have cash in an account earning little to no interest, it now makes sense to shop around to find a higher interest rate. Whether you use a high-yield savings account, a money market fund, or even short-term T-bills or CD’s, there are many options available now.
Harvest losses for tax purposes where you can. We talked about this last quarter for bond funds but with the further declines in stocks, you might now also have stock funds with unrealized losses. Taking those losses now can help offset gains later in the year or in future years.
Consider a Roth conversion if you have significant assets in tax-deferred accounts. We often preach the benefits of shifting tax-deferred money into Roth accounts and paying tax at lower rates while you are in low-income years. These Roth conversions are even more attractive when the value of the assets in your tax-deferred accounts has declined. If it makes sense to do a Roth conversion, doing so when values are depressed will lower your tax bill and allow you to move more into tax-free Roth accounts.
As always, we are here to help you get through these challenging times. Please reach out to us if you would like to discuss your finances.
-Chris Benson, CPA, PFS