“Ding! This is your Captain speaking….”
The pilot wasn’t coming on the radio to thank us for flying with Delta. He was calmly telling us more turbulence was around the corner. On came the seatbelt sign. And for the next few minutes (what seemed like days), the plane bounced all over the place. It wasn’t fun, but it’s just part of flying.
Turbulence on a plane is normal. It happens all the time. When your feet are firmly planted on Earth, turbulence is easy to comprehend. You can be unemotional and rationally discuss it. However, when you are at 30,000 feet and turbulence enters the equation – suddenly it feels different – because you are living it. It is very easy to mentally leap forward that something worse is right around the corner.
Turbulence in the markets is normal. It happens all the time. As a non-investor (with your feet firmly planted on Earth), turbulence (volatility) is an easy concept to comprehend. You can be unemotional and rationally discuss it. However, when you’ve got the lion’s share of your assets invested, it’s easy to mentally leap forward that something worse is right around the corner – i.e., the investment plane is going to crash.
Investing is hard. Context in these situations goes a long way, so let’s start there. Below you’ll find a great chart. Year by year, it shows the actual return (noted above the blue bars). Under each blue bar, you’ll see a red dot. Those red dots show the low point of the market in that given year. For instance, check out 2010. The market ended the year with a 15% positive rate of return, but at one point in the year, the market was temporarily down 16%. Most investors want to pull the ejection handle and get out at this point.
Source: Bloomberg. As of April 26.
There’s another interesting trend we’d like to point out: how markets behave in midterm election years. Below you’ll find a chart that shows how the market typically performs on average over the course of a year. Focus on the black line. You’ll see that on average over the last 91 years during the months from Jan to July the market typically goes up. But from July to Nov, on average it is flat. Then around November, again, on average, it typically finishes the year strong.
Sources: Capital Group, RIMES, Standard & Poor’s. Each point on the lines represents the average year-to-date return as of that particular month and day and is calculated using daily price returns from 1/1/31–12/31/21.
Now, look at the blue1 line. The blue line strips out the midterm election years and averages those together – which includes both political parties coming in or out of power since 1931. Notice, in midterm years from January to November, over the average of all those midterm years the market basically trades flat. But in November the market finished strong. Why? That’s because for 10 months there is a lot of uncertainty in midterm years. How many seats will be lost or won in the Senate? Ditto for the House. The market doesn’t like uncertainty. But regardless of party affiliation, as soon as the market knows who is in power and the agenda, on average it moves upward. There is no reason to think that 2022 is any different – over the last 6 months we’ve seen or heard speculation on a dozen bills that deal with a thousand permutations of raising taxes, estate tax changes, student loan forgiveness, Build Back Better initiatives, Billionaire taxation and SECURE Act 2.0. The list goes on and on.
Let’s take a peek at where we are for the year with regards to the rate of return for different asset classes. Keep in mind, you, like most of our clients, typically own some combination of stock and bonds (depending on their goals and the plans we’ve built for them). When stocks go down, bonds typically maintain their value or go up. And vice versa. This creates a teeter-totter effect. However, this chart shows you all the major investment classes (stocks and bonds) year to date. And there has been nowhere to hide.
Source: Bloomberg. *Price Returns through April 26.
So is the teeter-totter broken? We wouldn’t say it’s broken, it’s temporarily bent. Why? Simultaneously the stock market has suffered from the uncertainty of war in Ukraine, speculation of tax hikes, supply chain issues, digesting interest rate changes and inflation concerns. While the bond market has had to digest inflation concerns and trying to understand where the Fed is headed with interest rate hikes. This is certainly unusual, but there is historical precedent for this. We need look no further than the 1970s.
In 1973: S&P 500 was down -21.17% and 10 Year Bonds were down -4.64%
In 1974: S&P 500 was down -34.04% and 10 Year Bonds were down -9.21%
In 1977: S&P 500 was down -12.82% and 10 Year Bonds were down -5.07%
In 1978: S&P 500 was down -2.03% and 10 Year Bonds were down -8.99%
The teeter-totter was bent for a variety of reasons back then too: recessions linked to oil prices and Federal Reserve policy2. This wasn’t fun for investors. But the great news is that it came to pass. The turbulence ended. Since 1973, we’ve had 7 recessions and 7 recoveries. Since that time, the S&P 500 has grown from 783 to 4,131 (as of 4/30/22)!
We have been very proactive coming into this situation. In February, we became more defensive in our allocations and have been in the process of making the following changes:
As for the stock component:
- In a rising interest rate environment, tech and growth companies don’t fare as well. So we cut exposure in tech by 6% and tilted the equities more toward value (vs growth).
- We kept Non-US stock exposure below industry averages due to geopolitical concerns.
- We kept our Non-US emerging market below industry averages for the same concerns.
- We reduced the risk and improved the efficiency.
As for the bond component:
- We shrank the duration of our bond maturities down to roughly three year averages which reduces the volatility of their values in a rising interest rate environment.
- We also added in more active bond money management for a more offense approach to the environment.
- Due to the geopolitical events, we eliminated direct international bond exposure.
- Added in alternative bond strategy like the merger arbitration fund (where possible).
These have been some concerning times. But concerning times happen over and over. It’s in those moments, much like on the airplane, I appreciated hearing the pilot’s voice. He was calm and cool under pressure. I hope this email serves the same purpose given the choppy markets. Cooler heads prevail in turbulent times.
As always, your Wealth Manager stands ready to talk with you should you have any questions or concerns.