The Stock Market

If it feels like the first half of 2022 was one of the most challenging periods you’ve experienced in your investing lifetime you’re not alone. In fact, you would be objectively correct in your assessment!  So far in 2022 four of the first six months have produced negative returns. The S&P 500 closed the month of June down 8.25%, -16.45% for the second quarter (the worst Q2 since 1970’s -18.87%) and -20.58% year-to-date (the worst start to a year since the first half of 1970.)  The S&P 500 is now “officially” in a bear market, defined as a decline of greater than 20% from the most recent high.  At its low point in June the S&P 500 closed -23.55% below the January 3rd record high of 4,796.56.

Mid- and small-cap stocks did not fare any better with both the S&P 400 Mid Cap, -22.05%, and the S&P 600 Small Cap, -23.06%, below their record closing highs. Globally, stocks have also sold-off with the MSCI World Ex-U.S. -18.76% YTD.

Fixed Income

Perhaps even more shocking has been the sell-off in the bond market so far in 2022.  For what has historically provided the shelter during the storm, the bond market was unable to deliver the traditional stability investors have been accustomed to during bouts of stock market volatility. Through June 30th, the Bloomberg U.S. Aggregate Bond Index returned -10.35%.  Going back to 1976, it was the worst first half performance ever for the bond market and the third worst 6-month period on record over the same time span.

Conclusion

The toxic brew that has set the stage for the types of returns we’ve witnessed so far this year for both stocks and bonds are well known: war, inflation, surging oil and commodity prices, supply shortages, Central Bank tightening, rising interest rates, etc.  We’ll spare any further commentary on these matters as it’s unlikely to provide much additional insight beyond what we’ve all either read or heard about ad nauseam in the past 12-18 months.

Instead, we’ll offer the following thoughts on where things stand today and what lessons history might teach us about how things progress from here.

The past six months is a good reminder of the fact that stock prices do indeed go down from time-to-time.  Going back to 1939 the stock market has had 16 periods during which the price of the index declined by at least 20%, which translates to approximately once every five years.  Prior to the current bear market and excluding the sell-off sparked by the initial Covid-19 lockdowns in February/March of 2020 (in which the S&P 500 fell by 34% in less than a month and fully recovered by August of that year), the last time we experienced a decline of 20% or more was during the Global Financial Crisis that lasted from late-2007 through early-2009. Meaning it’s been well over a decade since the last bear market ended.

Stocks (and bonds) are priced to deliver better returns today than they were six months ago.  This is the silver lining to market selloffs.  When stocks are going up and everything seems to be going well it’s easy to feel good about being an investor.  The reality is that bear markets are where the money is made over the long run.  The past six months ranks in the worst 2% of rolling six-month periods going back to 1970.  Over that time span there have only been 11 other six-month periods where the market has experienced similarly poor returns.  Following each of those declines the market was higher over the following six months in all but one, and over the following year the market was higher every time.  Markets not only rose, but they rose significantly with an average return of nearly 18% over six months and nearly 32% over the following year.

Does this mean we’ve seen the bottom in the current sell-off and the market is ready to take-off from here?  Unfortunately, the best answer we can give to that question is “we don’t know.”  While the decline does set the stage for better long-term returns, in the short run anything is possible.  The “R” word (recession) continues to get kicked around with many who believe we already are in one.  Again, we’ll leave that to the talking heads on TV to debate. But if we look at the history of bear markets since the Great Depression, once there’s been a drawdown of 20% there was an average additional downside of -16%.  That’s the bad news.  However, the good news is that the odds favor strong returns over the following 1, 3, and 5 years.  As the chart below shows, returns over the 1, 3, and 5 years following a 20% drawdown average in the low- to mid-teens.

Markets will never follow the exact same path as they have in the past.  Each environment that surrounds any given bear market or economic scenario is unique, including this one.  What will always remain consistent is the fact that investing involves risk. Stocks (and bonds) can and do go down, but the ability to patiently endure periods like the one we are living through now are what eventually provide the returns that allow wealth to compound and grow over the long-term.

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