Hello, clients and friends of Integrity Wealth Advisors. We hope you are enjoying a summer of vacations, relaxation (market returns notwithstanding) and time with loved ones. Thanks to the leadership of Larry Dozier, the hard work of everyone on the volunteer team, and the generosity of our community (including many of you), Integrity’s annual charitable golf tournament last month was an incredible success. We were able to raise $60,000 for the Shield616 organization. If you don’t know their story, it will be well worth your time to learn more about them at https://shield616.org/.
Review of the Quarter
“It ain’t about how hard you hit. It’s about how hard you can get hit and keep moving forward. How much you can take and keep moving forward. That’s how winning is done!”Sylvester Stallone – Rocky Balboa
Rapidly-increasing inflation, rising bond yields, supply-chain challenges, the Russia-Ukraine war, and China’s handling of COVID all made for a challenging second quarter of 2022 for the global market and economies. While we know that over the last 100 years stocks have always recovered from bear markets, it can still test our patience and emotions. Typically, when stocks have pulled back this much the bond markets provide us with a nice offset. This time, however, with the Federal Reserve (“Fed”) raising interest rates to tame inflation (about a year late?), we have experienced negative returns in both stocks and bonds (see below). The major stock indices moved into bear market territory in June (defined as a 20% pullback from the recent peak). During the quarter, bonds outperformed stocks (albeit by being less negative), international stocks outperformed US stocks, and value stocks beat growth stocks. It is noteworthy that the positive three and ten-year annualized returns include the 2022 YTD performance.
|Asset Class||Index||2nd Quarter 2022||Year-to-Date 2022||Three Years (Ann.)||Ten Years (Ann.)|
|US Stocks||Russell 3000||-16.7%||-21.1%||9.8%||12.6%|
|Foreign Stocks – Developed World||MSCI EAFE||-14.5%||-19.6%||1.1%||5.4%|
|Foreign Stocks – Emerging Markets||MSCI EM||-11.4%||-17.6%||0.6%||3.1%|
|US Inv-Grade Taxable Bonds||Bloomberg US Agg. Bond||-4.7%||-10.3%||-0.9%||1.5%|
|US Municipal Bonds||Bloomberg Municipal Bond||-2.9%||-9.0%||-0.2%||2.4%|
|US High Yield Bonds||ICE BofA US High Yield||-10.0%||-14.0%||0.0%||4.4%|
Index data from Eaton Vance and PIMCO
The trillions of dollars spent on monetary and fiscal stimulus for the US economy was designed to mitigate the fallout from the pandemic. While it was helpful, it also ignited inflation. The Fed’s bond purchases (“quantitative easing”) increased its balance sheet from $5.8 trillion at the start of COVID to $8.9 trillion as of the end of the 2nd quarter 2022 (Bloomberg, First Trust). As defined by the Consumer Price Index (CPI), the trailing 12-month inflation rate grew to 9.1% in June. This is the highest it has been since the early 1980s (First Trust). The Fed has begun focused measures to reduce inflation. More on those measures below.
Interest rates have increased substantially this year (influenced by the Fed) which has pressured bond prices downward. The silver lining is that rising bond yields are a welcome sight for income-driven investors.
History suggests that the markets won’t stay down indefinitely, and we agree. Let’s look ahead.
There is plenty of talk about a recession in the US economy. Despite what we hear daily from the breathless media, negative GDP is not the only component of a recession. The National Bureau of Economic Research is the organization that officially determines when recessions have occurred. They consider the job market and other data points in addition to GDP. The job market continues to perform, incomes continue to rise, and according to Moody’s Analytics plenty of stimulus cash still remains in bank accounts which could support additional consumer spending. These data points are atypical of a recession. According to the analysts and economists we follow, if one occurs it will most likely not be this calendar year.
To combat inflation, the Fed has raised the Fed Funds rate in 2022 from a range of 0.00% – 0.25% to 1.50% – 1.75%. They have clearly communicated that more and significant increases are coming. While their target is 3.25% – 3.50% by year-end 2022, Kathy Jones, Chief Fixed Income Strategist for Schwab, recently commented they may stop at 3.00% or below. Additionally, the Fed began reducing their bloated balance sheet in June (“quantitative tightening”). The plan is for a reduction of up to $47.5 billion per month for three months then increasing to $95 billion per month until they reach what they determine as their “optimal range”.
If and when a recession does arrive, keep in mind that is not a reason to sell out of your investments. One could argue that the recession has already been priced into the markets so if no recession occurs, or it is milder than anticipated, the markets may rebound quickly. The markets are resilient. Historically, a year after the S&P 500 index (US Large Cap stocks) crosses into bear market territory (as stated above, this means a 20% decline from the recent high), it has rebounded by approximately 22% on average. Five years after, the average cumulative return is over 70%. See data below from Dimensional Fund Advisors.
Past performance is no guarantee of future results. Short-term performance results should be considered in connection with longer-term performance results. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Market declines or downturns are defined as periods in which the cumulative return from a peak is –10%, –20%, or –30% or lower. Returns are calculated for the 1-, 3-, and 5-year look-ahead periods beginning the day after the respective downturn thresholds of –10%, –20%, or –30% are exceeded. The bar chart shows the average returns for the 1-, 3-, and 5-year periods following the 10%, 20%, and 30% thresholds. For the 10% threshold, there are 29 observations for 1-year look-ahead, 28 observations for 3-year look-ahead, and 27 observations for 5-year look-ahead. For the 20% threshold, there are 15 observations for 1-year look-ahead, 14 observations for 3-year look-ahead, and 13 observations for 5-year look-ahead. For the 30% threshold, there are 7 observations for 1-year look-ahead, 6 observations for 3-year look-ahead, and 6 observations for 5-year look-ahead. Peak is a new all-time high prior to a downturn. Data provided by Fama/French and available at mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html. Eugene Fama and Ken French are members of the Board of Directors of the general partner of, and provide consulting services to, Dimensional Fund Advisors LP.
An additional image that supports staying disciplined during times like this is from OneAscent. The data set is the years 2000 through present day which covers the tech bubble, the global financial crisis, and the COVID pandemic. It reflects the growth of $1 in a 60/40 balanced portfolio for the one year following a six-month loss. In all but one case, the portfolio increased by at least 24% during that year; in the one exception year, the return was basically flat.
What has happened in the past is no guarantee of where things will go from here. We are hopeful that diversified portfolios will experience a recovery similar to the strong examples reflected above.
We know that market pullbacks and bear markets are inevitable, and we recognize they can create unwanted angst. We also know that an unexpected favorable shift in the economic fundamentals could fuel a sharp rally since sentiment today is quite negative. As we have seen from over 100 years of stock market history, bear markets inevitably run their course and a new bull market begins. We know times like these can be difficult. If you have questions or would like to talk, we are only an email or phone call away.
A good way to verify that you are still on track towards your long-term financial goals is to work with your advisor to create or update your financial plan. A thorough plan will include a stress test of your financial situation for market environments just like we are experiencing now.
A comprehensive approach to investing includes planning, a properly-designed portfolio, and an advisor that understands the importance of both. Our credentialed team at Integrity Wealth Advisors has decades of experience, the necessary tools, and the desire to see success for all of you.
Let us know if you have any questions.
Thanks and enjoy the rest of your summer!
– The Integrity Team