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It was an exceptionally difficult quarter for investors. In response to surging year-over-year inflation—the CPI came in at 8.6% in May—the Federal Reserve flexed its inflation-fighting muscles with two aggressive, record-setting interest rate hikes in both May and June. In June, the Fed also quietly began its new “quantitative tightening” policy whereby the Fed will allow bonds to roll off its balance sheet (i.e., as bonds mature, proceeds will no longer be reinvested in new bonds). The yield on the 10-year U.S. Treasury rose to 2.98% by the end of the second quarter, up from 2.32% at the end of May and 1.52% at the end of 2021. In a foreboding sign for home prices, rates on 30-year mortgages rose to its highest levels since January 2008, reaching 5.7% at the end of June 30—up from 4.7% in March and 3.1% at the end of December1.
Global financial markets turned sharply negative on the news. U.S. stocks2 returned -16.7% for the quarter and are now down -21.1% for the year.3 Non-U.S. stocks posted nominally better, albeit still negative returns; developed market non-U.S. stocks4 returned –14.3% in the second quarter and -19.3% for the year; emerging market stocks5 returned -11.3% for the quarter and -17.5% for the year. Global bonds6 offered little solace, returning -8.3% in the second quarter and -13.9% YTD through June 30. More speculative assets like growth stocks and cryptocurrencies saw the worst of it. For example, U.S. growth stocks—the best performing stocks for much of the past decade—declined 21.8% for the quarter and are now solidly in bear market territory, returning -28.2% for the year. Bitcoin, the largest cryptocurrency by market capitalization, returned -57.3% for the quarter and is now off more than 70% from its all-time high in November 2021.7
It is unknown whether the U.S. economy is in recession. The data is ambiguous at best—and it’s always more than a bit stale given the backward-looking nature of economic data. The Atlanta Fed’s GDPNow model, probably the most real-time model of its kind, estimates the U.S. economy is already in recession with second quarter GDP growth running at -2.1%.8 However, other data tells a different story; for example, unemployment remains near 50-year lows9 and June’s jobs report came in stronger than expected.10 Therefore, for the moment it remains unclear whether the U.S. economy will tip into recession. Regardless, given such a high degree of uncertainty, it helps to step back and take stock of what we know and don’t know.
First, if the economy tips into recession, we don’t know how severe or long-lasting it would be. There is no reason to think it would be deeper or longer than average. Unlike 2008, the U.S. banking sector today is not overleveraged and is, in fact, well-capitalized. Similarly, unlike March 2020, the pandemic has largely subsided, at least outside China and other emerging markets. But we know from history that since 1946, the average recession has lasted an average of 10 months and the average expansion has lasted for over five years.11 To quote JP Morgan’s David Kelly, we still live in a “world of short winters and long summers”.12
Second, we don’t know when the bear market for U.S. stocks will end but we do know that bear markets, defined as a decline of 20% or more, are normal. There have been 26 bear markets in the S&P 500 Index since 1926—about one every 4 years—lasting an average of 9.6 months.13 If you’re keeping track, the market last peaked on January 3, 2022—meaning today’s bear market is approximately 6 months old.
Finally, we don’t know when the economy or bear market will hit bottom. However, we do know from history that the market is forward-looking and tends to lead the economy. Said differently, markets tend to bottom before the economy does. Consequently, attempting to time markets in anticipation of an economic recession—which is only identified in hindsight using data that is weeks or even months old—is not a good idea. Despite 12 recessions and 12 bear markets since 1947, the S&P 500 Index has returned 12.57% annually.14 Further, markets have historically posted exceptionally strong returns in the wake of bear markets. Since 1926, U.S. stocks returned an average of 22.2% in the first year following a 20% decline—and a cumulative return of 71.8% after five years.15 The takeaway is that it’s far better for investors to be strategically well-positioned to benefit from rising markets than to try to tactically trade around declining ones.
1 Source: YCharts.
2 Russell 3000 Index.
3 Source: YCharts, Inc. All data as of June 30, 2022.
4 MSCI EAFE
5 MSCI Emerging Markets
6 Barclays Global Aggregate
7 Source: YCharts.
8 Federal Reserve Bank of Atlanta
9 See JP Morgan’s Guide to the Markets, June 30, 2022, slide 27.
10 US Bureau of Labor Statistics, “Employment Situation Summary”, July 8, 2022.
11 “Recession Risks & Investment Implications”, JP Morgan Notes on the Week Ahead by David Kelly, June 22, 2022.
13 Source: Hartford Funds, “10 Things You Should Know About Bear Markets”
14 Source: FactSet, Inc. Rolling 1-year returns since 1947. Analysis of 906 rolling 1-year periods using monthly returns data for the period January 1947 – June 2022.
15 “History Shows That Stock Gains Can Add Up after Big Declines”, Dimensional Fund Advisors, June 2022. Data is the Fama/French Total US Market Research Index, July 1926 – December 2021.
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