It was a difficult week for investors. To combat piping hot inflation, the Federal Reserve raised interest rates 75 basis points, the largest rate hike since 1994. The “Fed Funds” rate—the annualized rate at which banks lend to one another overnight—now stands at 1.63%1–precisely where it stood just prior to March 2020 and the onset of the COVID pandemic. For the week, U.S. stocks fell 6%, officially entering bear market territory (defined as a decline of at least 20% from previous highs) and are now down 24% YTD.2 Despite the Fed’s big rate hike on Wednesday, bond yields actually fell following the Fed’s big announcement, pushing bond prices higher over the past two days—further evidence that investors should never try to time markets no matter how confident they are in their forecasts.
But amidst the darkness, there is also light. Not all asset classes are of course down 24%. Intermediate bonds, for example, despite a difficult year, are down 11%; short-term, high-quality bonds are down significantly less, about 5% for the year.3 But any discussion of bond returns would be incomplete without acknowledging the fact that interest rates have risen significantly; bond investors can now expect significantly higher income from their bond allocations going forward. For example, the yield on intermediate bonds has risen by 1.75% at the end of December to 3.92% as of yesterday’s close; the yield on high yield (below investment grade) bonds stood at 8.56%.4
Additionally, stock valuations have come down significantly and now stand at 15.8 times earnings—their lowest since the market lows of March 2020; they now stand at about 6% below their 25-year average.5 And earnings growth continues to push valuations still lower; despite a rapidly slowing economy, year-to-date earnings growth stands at 7.4% for S&P 500 companies.6 Stocks have become both cheaper and more profitable at the same time. But while additional earnings growth in the immediate near future remains questionable (due to the increasing prospect of recession), the Federal Reserve has made it unequivocally clear to markets that it is fully committed to combating inflation. In addition to aggressively hiking interest rates—not once but twice in the past 5 weeks—the Federal Reserve is also beginning “quantitative tightening”, a process whereby they will passively allow the more than $9 trillion in bonds on its balance sheet to mature.
My intent in highlighting some positives in the data isn’t to be pollyannish but rather clear-eyed about where we stand at the moment. Bear markets are nothing new—in fact, there have been 26 bear markets since 1926 (about one every 3.7 years) lasting an average of 289 days.7 Subsequently, bear markets are not a reason to sell; they all have a beginning, a middle, and end. While we can’t predict when exactly it will end, we should have no doubt that this one too shall pass. And as we showed in our last Market Update, market returns have historically been quite strong in the 12- and 36-month periods following a 20% market decline (about 22% and 41%, respectively). What that means in practical terms is that markets have, at least historically, recovered bear market losses within about 12 months.
In closing, no one likes negative returns or volatile markets. But, as I wrote earlier this week, they’re an ever-present, random, and recurring aspect of investing, one that can’t be simply wished away or avoided through fad investments or exotic investment strategies. Our advice is to remain focused on evergreen, time-tested strategies for helping beat bear markets: sound financial planning, broad diversification, and a disciplined, long-term perspective.
1 The Fed funds rate is technically a range; the current target range is 1.5% – 1.75%.
2 US stocks = Russell 3000 Index. Data as of June 17, 2022
3 US bonds = Barclays US Aggregate Bond Index; Short-Term Bonds = Vanguard Short-Term Bond ETF
4 JP Morgan Guide to the Markets, June 16, 2022, slide 36.
5 Ibid, slide 5.
6 Ibid, slide 7.
7 Hartford Funds. See: https://www.hartfordfunds.com/dam/en/docs/pub/whitepapers/CCWP045.pdf
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