Second Quarter Market Update: Sunglasses & Umbrellas
When it comes to the markets, the summers (good times) tend to be long, and the winters (tough times) are often short as bull markets are more enduring than bear markets. Despite the beautiful weather this time of year, stock and bond markets have disappointed so far in 2022; however, we must remember that four of the five years leading up to this year were very strong. Just as rainy and cold days are inevitable, so are volatile and disappointing market returns every now and then.
Continued issues with COVID-19 abroad (primarily in China), persistent supply chain issues, the Russia/Ukraine conflict, and strong U.S. consumer demand have led to elevated levels of inflation in 2021 and 2022. This environment has put pressure on the Federal Reserve to aggressively raise short-term interest rates. While gas prices have recently started to come down, they are still high enough to cause consumer sentiment to be at multi-decade lows. Stocks have experienced the worst beginning to a year since 1970, and bonds are having their worst year on record. The current debate among economists is whether we are already in a recession or whether it will occur later in 2022 or 2023.
Mid-year is a good time to reflect on the first half and look forward to the second half. The issues weighing on the markets and economy have been well documented, but there are plenty of reasons for optimism, especially given the longer-term perspective of investors. Consumer and corporate balance sheets remain strong, with the ability to weather an economic slowdown. U.S. financial institutions (i.e. banks) are stable, passing periodic “stress tests” with flying colors. The housing and job markets have consistently been positive factors throughout the pandemic rebound. While both may cool off in the coming quarters, they should remain the foundation of a good economy.
As previously mentioned, the capital markets have struggled this year. For the three months ending June 30th, the U.S. equity markets represented by the Russell 3000 declined by 16.7%, while international stocks (MSCI ACWI Ex U.S.) held up a little better but still dropped 13.7%. U.S. bond markets as measured by the Bloomberg U.S. Aggregate Bond Index returned -4.7%. Broadly speaking, these quarterly declines have led to year-to-date returns for all asset classes ranging from -10% to -22%.
Looking forward, Dow Jones Market Data has revealed that stocks tend to do well one year after entering a bear market, which occurred in June. For example, the median one-year return after stocks have experienced a 20% decline is a positive 24% return. Also, while stocks tend to be volatile heading into mid-term elections, the one-year return following the mid-terms has historically been strong. With the substantial pull-back in the equity markets, valuations have improved and are now more consistent with historical averages, even though interest rates are still relatively low. This combination could bode well for market performance over the next 5-10 years.
It is tempting to closely monitor media reports of inflation, the direction of the economy, and the volatility of the capital markets, but we encourage you to spend time doing the things you enjoy this summer. On any given day, stocks are almost as likely to be down as up, but over one-year periods, stocks have historically been positive 75% of the time, and over five-year and ten-year periods, stocks are almost always positive. In other words, sunny days occur more often than rainy days, so while we must own an umbrella, it is not needed near as often as our sunglasses!
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