Every spring, the bears in Colorado’s high country come out of hibernation. (In fact, we just had one – pictured below – stop by for dinner with us the other day.) Thankfully, bear markets are not quite so regular. But they do occur periodically and we are experiencing one right now. Interestingly, use of that term to describe bad markets goes back centuries.
Stocks suffered their worst first half since 1970. The S & P 500 (Total Return) Index lost 16.10% for the quarter and 19.95% for the first half.
For just the second time in 40 years both stocks and bonds posted losses for two consecutive quarters.
Primary responsibility for the double dose of carnage lies with the Fed raising interest rates to combat inflation – including a three-quarter of a percentage point increase in the federal funds rate in June, an amount not seen since 1994.
The benchmark Bloomberg Aggregate US Bond Index fell 4.69% in the quarter and is down 10.35% for the year. However, due to their lower sensitivity to interest rate changes, short term bonds, measured by the US 1-5 year Core Bond Index, fell only 1.2% in the quarter.
Virtually all asset classes have suffered. International developed markets were down 14.66% and emerging market stocks dropped 11.45%. Global real estate fell by 17.22%. Cryptocurrency, which was assumed by some to be a savior, has proved to be a dud.
Perhaps anticipating a moderation of inflation, commodities had their first down quarter in over a year, with the Bloomberg Commodity Index falling 5.6%.
The Fed remains on a knife’s edge – trying to moderate inflation by slowing the economy; but not cause a recession.
You may laugh at that concept. But it has some appeal. Volatility can be a killer of long-term returns. Remember, a 50% loss needs to be followed by a 100% gain to break even; so steadier returns are an advantage.
The more richly valued growth stocks like big tech (think the FAANGs) have been hit the hardest. (As a reminder, “growth” is generally defined as being relatively expensive and “value” is defined as relatively cheap, based on one or more metrics.) Value stocks were down only 7.31% for the quarter, while growth stock lost 34.26% – a disparity of 27%.
As a matter of fact, one of the consequences of the downdraft in growth stocks is that some of those high flyers have now become so cheap that they are now considered value stocks and will now be over-weighted in value-leaning portfolios.
We know that stocks are a volatile asset class, so we should neither be surprised nor frightened when it shows up. Bear markets are no fun. But we can’t obtain the long-term risk premium for investing in stocks without enduring the occasional downdraft. As this graphic shows, between 1926 and 2021, there have been 72 positive years and 24 negative years.
On a P/E basis, stock valuations were clearly stretched going into 2022. Rising interest rates, inflation and the war in Ukraine have certainly taken a toll on what might be argued, anyway, to have been a bit of irrational enthusiasm. Especially when you add in the crypto craze.
The silver lining is that prices and valuations are being restored to more sustainable levels.
Nobody knows whether this bear market will be short and shallow or long and deep. But here are some ideas for coping:
Stick to your plan. Patience and discipline are the most important traits to being a successful investor. Make sure you have a well thought out plan that you can stick with during bad markets.
Tax loss harvesting. If you have made purchases in a taxable account near the market top, you can sell these shares and book capital losses to either net against this year’s gains or carry forward into future tax years. $3,000 of losses can be deducted against ordinary income.
Further Diversify. Use the proceeds from sales to add a useful asset class that you didn’t previously hold in your portfolio; such as a value fund, commodities fund or inflation protected bond fund. But maintain enough in cash and bonds to fund your spending or emergency needs during the bear market.
Rebalance. With stocks falling more than bonds, there is still an opportunity to rebalance back to your strategic allocation.
Roth Conversions. Assuming a Roth conversion makes sense tax-wise, you can convert more shares for the same dollar amount of taxable income; similar to dollar cost averaging.
Don’t Act on Fear. Investing is a marathon and hopefully a long one – for the benefit of your lifetime and future generations. Markets can rebound in a hurry. Maintaining a long-term strategy is usually the best bet. Maybe even enjoy the fear?
And, most importantly, appreciate life’s simple pleasures.
Steve Smith, Principal of Right Path Investments is here to guide you with preparations to take your next step. If you're ready to take that step, schedule some time for a one on one with Steve today.