The first six months of 2022 were challenging for investors.
The S&P 500 lost 20%, its worst first half since 1970, with growth stocks falling at an even faster rate.
But what made the period truly unique is that the U.S. aggregate bond market suffered a loss of even rarer magnitude, down just over 10%. In the last eight calendar years when the S&P 500 fell, bonds were positive, providing an important ballast.
Inflation & Interest Rates
This year has been something of a perfect storm. On top of market performance, inflation is eroding spending power at the fastest rate since the 1980s.
Global stocks officially entered bear market territory (down 20+%) in June after U.S. inflation numbers showed an 8.6% yearly increase in consumer prices, surprising many who believed inflation had already peaked.
The Fed responded aggressively by raising interest rates 0.75% and signaling short term rates would approach 3.5% by yearend. Higher interest rates make stocks less attractive relative to bonds and rising rates suppress economic activity and increase the odds of recession.
Bear markets are uncomfortable and difficult, but steep drawdowns are part of every market cycle. They are required for high long-term gains to be possible. If this turns out to be an “average” bear market, it suggests there is more to endure. However, a moderate bear followed by a moderate recession is a reasonably likely scenario in our view.
The stock market and economy are different things. Markets usually move in advance of economic data, with sharp recoveries often materializing before of the depths of an economic slowdown are reached. We believe equity prices already reflect at least a mild recession in 2022-2023 and that an economic slowdown need not bring material further market declines. Risk of a steeper recession remains, and there is considerable upside potential if a slowdown can be sidestepped.
The Bottom Line
Missing the next up-move is likely a bigger risk to long-term results than participating in whatever downside may be left in this bear. As a reminder of how fast recoveries can happen, in 2020 U.S. stocks were down over 30% on March 23 but finished the year up over 20%. Likewise, with yields now higher, we expect bonds to contribute positive returns in the second half of the year.