Windsor Perspective: Q3 2022
The second quarter of 2022 was another difficult quarter for investors. Combined with the first quarter, the first half of 2022 is going down in the history books for all the wrong reasons. With the S&P 500 down 20.6% YTD, this positions 2022 to be one of the worst starts to a calendar year since 1940. The only two worse years were 1962 which experienced a -23.5% at the halfway mark while 1970 had a -21% return. The markets have reacted to a much stronger than expected surge in inflationary pressures which triggered a much more aggressive response from the Federal Reserve. The result has been negative returns in both the equity and fixed income markets two quarters in a row. However, there does appear to be evidence of inflation beginning to slow, though it will take months to potentially resolve itself. Despite the current market performance, staying invested and following your plan has proven to be the path to follow in all prior downturns.
In this edition of the Windsor Perspective, we review the market performance for the second quarter of 2022, and discuss the merits of staying the course despite the stormy seas.
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Q2 of 2022 - Hard to sugarcoat
The second quarter of 2022 was disappointing. The S&P 500 delivered the second worst quarterly performance since 2008, reporting a total return of -16.11% for the quarter. Similarly, the fixed income market, represented by the Barclay’s Aggregate, had a total return of negative 4.58%. This was the second worst quarterly performance for the fixed income market in over 40 years. Unfortunately, the only worse quarter in over 40 years was the first quarter of 2022.
S&P 500 Index Q2 2022
Source: Bloomberg, Windsor Wealth Management
S&P 500 Index 1-year
Source: Bloomberg, Windsor Wealth Management
Of the 186 quarters since 1975, a negative quarterly return for both stocks and bonds has occurred just 20 times, as shown in the table below. Moreover, of the 186 quarters since 1975, this is only the 5th time we have experienced consecutive negative quarters for both equities and fixed income (highlighted in yellow).
Quarters With Both Negative Returns for Stocks & Bonds Since 1975
Source: Strategas, Bloomberg, Windsor Wealth Management
In the quarter following consecutive negative declines for both equities and fixed income, bonds have delivered a positive response 4 out of 4 times while equities were up 3 out of 4 times. The once instance where equities continued to decline was the financial crisis in 2008.
Performance in the Quarter Following Two Negative
Quarters for Both Stocks & Bonds
Source: Strategas
As of the end of June, the S&P is down 21% from its peak in January and struggling for the third time in four years. It is worth looking at these prior major pull backs and the subsequent recoveries for context. In 2018 the market was down 19% while it was down 35% in 2020 from its peak. However, as shown below, both times the market bounced back in a “V” shaped recovery. And more importantly, the market is falling from a new high each time. Time will tell how the recovery happens this time.
3 Large Market Declines in Four Years
Source: Bloomberg, Calamos
Looking at the market from a 40,000 foot level, we see that “bear market” type of declines happen every few years, but are more than offset by much stronger recoveries in the market. Although these declines feel painful at the time, looking at the full cycle shows the returns have always far outperformed the periods of loss.
Large Rises versus Smaller Declines (S&P 500 1949-2021)
Source: Calamos Investments
But why does it feel so much worse this time around? First, investors have grown very comfortable with the markets and the very good returns the past 12 years. Outside of the two short lived pullbacks mentioned earlier, we have essentially been in a long-term bull market. Thus, any pullback feels extra painful. Second, the market is forcefully reminding investors that investing involves risk. This is shown by the number of negative days vs positive days so far in 2022. This is the first time in many years where negative days outweigh positive days. In addition, there are more days down over 2% so far this year than in all of 2021 and in most years since 2012.
Percentage of Positive & Negative Days (S&P 500 2016-2022, as of 6/15/22)
Source: Calamos Investments
As we have written in our previous letters, the markets are reacting to uncertainty that is being driven by inflation at the highest levels since 1981, gas prices over $5.00, rising interest rates driven by a more aggressive Fed, concerns on corporate earnings coming down, declining consumer confidence, and if/when the economy will go into a recession. This is on top of underlying concerns such as Covid-19, the Ukraine war and supply chain disruptions. The key thing to remember is the markets are a discounting mechanism. In other words, the market is always looking forward 12-24 months and what is to come.
That last sentence is important, as the markets digest the future today and react far in advance of the actual data. Thus, the market will start going up well before the data gets better. Long term investors know this, and do not get caught up in the ups and downs of the market. As one fund manager we utilize, Calamos Investments, wrote: “at the completion of your investment plan, the value of what you’ve accumulated will be the result of your continuous participation over time”. Counter intuitively, if you try to avoid the bear market, you could miss most the of the best performing days in the market.
Sit Out a Bear Market & You Could Have Missed 62% of the Market's Best Days
Source: Calamos Investments
If you try to time the market, you must get two decisions correct: when to sell and when to reinvest. This is nearly impossible to get correct. As an example, if you had missed just 10 of the best market days over the most recent 20-year period, you would have reduced your return by more than half.
S&P 500 Annualized Returns & the Growth of $10,000
over 20 years (2001-2021)
Source: Calamos Investments
As mentioned, timing the market is nearly impossible. As an example, the Individual Investor Bull Bear Ratio is a well followed indicator of investor sentiment. As shown below, it is at the lowest levels in over 10 years. But as shown with the blue arrows, nearly every time it gets this bad, the market begins to recover. It is a contra indicator.
Individual Investor Bull Bear Ratio is Very Bearish -
Typically Happens Near Market Lows
Source: Bloomberg, Strategas
Moreover, using the bearish reading as a contrary indicator, market returns are historically very good when sentiment becomes this negative. The average 12-month return is 19.7% with a positive reading 97% of the time.
Average Returns of the S&P 500 After a Bearish Reading
Source: Calamos Investments
Not only have we reached extreme bearishness in the market, 2022 is following 1970 very closely. 1970 is the last time we were in a mid-term election cycle, we had high inflation, we had just come out of a pandemic and there was a war taking place. If history were to repeat itself, it would be wise to stay invested.
S&P 500 Returns: 1970 vs 2022 (as of June 30)
Source: Strategas
Granted, nobody knows what the market will do in the short term, especially after recently entering bear market territory. As shown below, the average bear market since 1929 is 14 months. But each bear market is different, ranging from less than a month to 36 months. We will have to wait and see how the current market evolves. In the meantime, staying invested for the long run continues to be the best option.
S&P 500 Bear Markets since 1929
Source: Charlie Biello, Compound Advisors
Similarly, each market correction of more than 10% is unique. Shown below is every 10%+ correction since World War II. The non-recession median pull back is 12.5% while the median pull back during recessions is 23.9%. The pull back experienced in June was just shy of the historical median during recessions.
Size of S&P 500 10%+ Corrections
Source: Macro-Ops, Shiller Data, Haver, Deutsche Bank
As mentioned, the market is singularly focused on the combination of inflation, the Feds reaction to inflation, and the potential for this reaction to result in a recession. Fortunately, there is developing signs that inflation is beginning to subside. Although we do not have room to include multiple inflation charts in this note, data shows declines in items such as: oil, gasoline, natural gas, food commodities, home prices, job openings easing = less wage pressure, rents, etc. As June and July are considered to be the toughest two months, we should begin to see more evidence as we go through summer. The one chart we will share is the inflation futures. As shown below, inflation futures have begun to recede from prior expectations. Though still high, it is going in the right direction.
Inflation Futures: Back to April 2022 Levels
Source: Fundstrat and Bloomberg
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In Summary
The second quarter of 2022 was another challenging quarter from a performance perspective, with both equities and fixed income markets delivering negative returns for a second quarter in a row. Although it is hard to predict the future and when inflation will begin to recede, the market has already discounted a slowing economy. However, we do not yet know exactly how much the economy will slow do to the rising interest rates. What we do know is no matter how rough the seas are, long term investors have always been rewarded for staying the course and not letting their investment plan drift. Eventually, the rough seas will pass, and we will see smoother sailing ahead.
As always, we will be seeking out opportunities for your overall financial plan based on the current economy and our outlook. Together, we will continue to tailor your plan to suit your unique financial objectives and a risk level you are comfortable with. Thank you for your confidence in our team and in Windsor Wealth Management.
If you would like to talk about any of the issues raised in this edition of Windsor Perspective, or any aspect of your financial plan, please contact us.
