While stocks rallied towards the end of March, the stock market turned negative again in April and for the beginning of May proving that March was more a bear market rally as opposed to a sign that the selling was over. Inflation continues to be perhaps the biggest risk for both the stock and bond markets with interest rates soaring as the bond market tries to anticipate the Federal Reserve’s future interest rate hikes. Despite the risks within the market, maintaining discipline during these times can be crucial in order to achieve long-term success for your portfolio. While it is difficult to predict the future, past selloffs can give us an idea of what we may expect for the future.
As of 5/12/2022 the S&P 500 Index is down 17.88% with the NASDAQ down over 27.96%. Naturally investors may want to sell out of the market in hopes of limiting future losses. The challenge here is that you’d have to guess right twice. You’d have to be correct that the market will continue falling AND you’d have to know the right time to get back in. Often investors can sell and maybe limit some of their losses in the short-term, but then they keep their cash on the sideline waiting until the coast is clear. The problem with this strategy is that by the time volatility declines, often the recovery in the market has already happened and you missed out on the markets rebound. Some are comparing this market decline to what we saw in 2018. The reason for this comparison is that interest rates were rising at the end of the year with expectation that the fed will enact a tighter monetary policy. This led to a 19% contraction peak to trough for the S&P 500, an over 20% decline in the NASDAQ and an over 25% decline in small cap stocks. If you sold out of the market during this time, it would have been a terrible decision. Why? Because the market roared back quickly into 2019 and finished the year up 33%. The NASDAQ did even better in 2019 posting an almost 38% gain. Those who didn’t panic and just maintained their investment strategy were able to recover and then some.
While this 33% gain a year later seems abnormally high, history says it’s just slightly above average. Per LPL Financial, “for every time the S&P 500 has dipped at least 10% since 1980, the index was higher one year later 90% of the time, and up 25% on average.” So, if you want to play averages, your best bet is to remain invested in your stocks as opposed to bailing.
The other thing to keep in mind is the volatility works both ways. Often times the best days of the stock market follow the worst days. When the market does rebound, it can quite quickly at times. As seen in the chart below from JP Morgan, missing the 10 best days from 2002-2021 would have caused your annual return to drop from 9.52% all the way to 5.33%. Simply remaining invested is clearly the rational decision when looking at this data.
If you purchased a 3-year Treasury bond when it was paying 1.5% it wouldn’t be worth as much today since a newly issued 3-year Treasury bond now pays around 2.8%. With that being said, that same 1.5% 3-year Treasury is still backed by the full faith and credit of the U.S. government. So, if you sold your treasury bond, you wouldn’t get as much as you paid for it since investors would prefer the 2.8% treasury, however, if you held it to maturity, you’d continue receiving your 1.5% coupon payment and then get your principal back when the bond matures. So you still wouldn’t have lost money. Despite this, your current investment statement will show this bond as declining in value as it reflects the current price the bond is worth if you were to sell it. This is the current situation bond investors find themselves in. The bonds or bond funds they purchased in prior years are not worth as much as they were before interest rates recently rose, however, risks of default are still low across the bond universe. In other words, the decline in bond prices is strictly interest rate driven. It’s not due to an increased risk that the lender will default. This is not like 2008 when sub-prime mortgage backed securities became almost worthless. Again, the decline in these bonds value is simply because interest rates rose.
One important point that bond investors should also be cognizant of is that going forward higher interest rates should allow bond investors to earn more income on their bond investments. In the previous example, if the 3-year treasury matured and if rates stayed elevated, the investor could then reinvest their proceeds into a new 3-year treasury earning this higher 2.8% rate. As financial advisors, it has been challenging to find interest paying investments with rates so low, however, the one positive for rising rates is that this is likely to change. If treasuries pay around 3% now, that means bonds issued by corporations will pay more than this since they have to pay more than what the safest government bonds pay. Ultimately what this means is that this short-term pain caused from rising rates can lead to longer term gain as bonds paying higher interest going forward.
Inflation has been the key driver pushing interest rates higher causing both stocks and bonds to decline year-to-date. While this decline is unpleasant, it is important to not bail on your investment strategy. We reiterate that your goal is to win in the long-term and that in order to do so you must be willing to accept occasional losses in the short-run. 2022 will be a challenging year but we look forward to coaching you and working together to help and advise you along the way.
CRA Investment Committee
Matt Reynolds CPA, CFP®
Tom Reynolds, CPA
Robert T. Martin, CFA, CFP®
Gordon Shearer Jr., CFP®
Jeff Hilliard, CFP®, CRPC®
Joe McCaffrey, CFP®