InvestingThrough a Bear Market
experienced one of the deepest plunges in history, with almost twenty-two million people laid off. The significant government stimulus packages have contributed to one of the fastest job recoveries, but may also have significantly contributed to the excess liquidity and strong consumer demand. This along with wage growth pressures are adding to the burden that the Federal Reserve now faces to get inflation back under control. The Federal Reserve Open Market Committee (FOMC) has begun the arduous process of raising the short-term Fed Funds interest rate to slow the current economy without stalling it. Some would say the FOMC is already late and perhaps should have been raising interest rates during 2021, following the historic lows in interest rates during 2020. Since that time, the bond market has been raising rates across the yield curve. The bellwether 10-year Treasury yield, which briefly hit 0.50% in August of 2020, is now hovering around 3% and has recently been as high as 3.5%. After their first two meetings of the FOMC this year, the Fed Funds rate has been increased by 1.00%. The FOMC is now forecasting that they will continue to be aggressively raising this rate, with a target of 3.5% by the end the year. Investors looking for the contrary indicators in this information should focus on the fact that the bond market had already anticipated that the FOMC was going to be more aggressive then the FOMC had earlier projected. The markets had already factored this into bond prices which is why some rates along the yield curve fell slightly on the news of the FOMC’s more aggressive stance. In addition, the bond market is also projecting that inflation is likely to become tamer in the near future. If bond investors were concerned about inflation for an extended period, interest rates
would not be hovering around 3% when inflation is currently above 8%. For bond investors concerned about the impact of inflation and rising interest rates on the economy, they should consider increasing their exposure to higher quality bonds and shortening the average maturity (duration) of their bond portfolio. For investors in the stock market, the valuation correction has hit the previously high-flying growth stocks quite hard, as their future cash flows are discounted back to current values using higher interest rates which equate to lower current prices. Generally ignored for the past dozen years, value stocks may offer better exposure to defensive sectors like consumer durables, energy, health care, and dividend paying stocks which may be less susceptible to a slowing economy and rising interest rates. Successful long-term investors have learned through the many cycles of the markets and the economy that the best strategy is to remain invested. They review their risk profile and confirm that their current allocation aligns with their long- term investment objectives. They also look to take advantage of the markets when they are trading at lower prices by rebalancing and putting to work any cash that remains on the sidelines. The best way forward may be straight through the bear market. Talk to your advisor if you have any questions.
Written and prepared by: Robert Janson, CIMA®, AIF® Senior Vice President, Senior Portfolio Manager, Wealth Services
Now that the S&P 500 Index has dropped more than 20% from its recent high point on January 3rd, the stock market has entered bear market territory. What makes this year especially difficult is that the bond market is having its worst downturn since at least 1976. During most drops in the stock market, the bond market usually provides some measure of stability. For only the third time since World War II, the stock and the bond market are both falling at the same time. The primary cause for this double hit is the same – rising interest rates. The cause for rising interest rates is the persistent inflation. For long-term investors, there are few safe havens from the current volatility. As successful investors have learned over the years, the best way forward may be straight through the bear market. There have been fourteen bear markets since World War II. The most severe was the Great Financial Crisis in 2008-2009 and the fastest bear market was the downturn in 2020 during the Covid-19 shutdown. The average bear market lasts about 15 months and average decline is about 32%. All bear markets are financially painful to experience and can be difficult to maneuver without a good strategy in place. The most important thing to remember about bear markets is that they eventually turn into bull markets again. Bull markets last much
longer than bear markets and have always resulted in long-term growth for investors who can withstand the short-term volatility. The start of the next bull market usually occurs when the current bear market conditions look the worst and the prospects for recovery appear the bleakest. One potential indicator of a contrary bullish signal for the markets is the Consumer Sentiment Index. This Index is a product of the monthly survey of consumers conducted by the University of Michigan since 1970. Currently, the level of this index is at its all-time low. Every other time this index hit an intra-cycle low, the stock market was higher by a minimum of 14% and an average of 24% over the next 12 months. Obviously, past performance is no guarantee of future results. The biggest factor contributing to the current negative consumer sentiment is the persistent inflation. Initially, the run-up of inflation was caused by the rapid recovery following the Covid-19 shutdown when consumer demand outstripped the ability for manufacturers to keep up with supply. The supply issues have continued with the Russian invasion of Ukraine and the Covid-Zero policy in China. However, the primary catalyst for the current inflation challenge turning from a “transitory” issue to a persistent one has been the very tight labor markets. Recently, the number of jobs available was almost double the number of people actively looking for a job. During the Covid-19 shutdown in 2020, job market had
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Personal Finance Quarterly | Summer 2022
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