By: Sean Gallagher, CFP®
The first half of 2022 has been a disappointing year for every investor. At the close of Q2 2022, a 60/40 hypothetical portfolio comprised of the S&P 500 Index and Barclays US Aggregate Bond Index was down over 12%. What's been the driving force behind these investment returns, and what can we expect moving forward?
Equities
To begin with the US stock market, we've seen volatility centered around geopolitical conflict (Russia vs. Ukraine), extremely high levels of inflation (supply chain issues, pent-up consumer demand), and rising interest rates (more costly for consumers and businesses to borrow). While these factors led the S&P 500 to an intra-year decline of around 24% at one point, this is not unprecedented, as shown in the JP Morgan Asset Management chart below.
While the red dots indicate S&P 500 intra-year declines each year, the gray bars illustrate that the calendar year returns ended positively for 32 of the last 42 years. There have been numerous years of 20%+ declines, and many of them have recovered considerably or even turned positive by the end of the year.
Fixed Income
An even more interesting story of 2022 is the performance of fixed income. Bonds play a significant role in a portfolio by reducing the impact of stock market volatility. Bonds typically have an inverse relationship with stocks, meaning when stocks go down, bonds will usually remain level or go up.
In a year like 2022 for the equity market, an investor would rely on fixed income to provide steady returns and reduce the overall portfolio loss. As shown in the chart below from JP Morgan Asset Management, The Bloomberg US Aggregate Bond Index is having its worst year since the index began tracking in the 1970s.
The main factor behind the poor fixed income performance has been inflation concerns. The longer-term bonds are pricing in higher inflation, so their yields have risen, and the prices have fallen. The pace of rising inflation is disrupting the bond market. As yields increase, current bond prices decrease because newly issued bonds with higher yields become more attractive to investors.
The positive of rising interest rates for bonds is that an investor will receive a higher yield on new bonds going forward. When measuring a bond's performance, it's essential to use total return, which incorporates both price return and yield. Higher bond yields should help the return on the bond funds over the next year.
Outlook
Have we weathered the storm, or is there still worse to come?
Our general outlook for an economic recovery is less of an if and more of a when.
While inflation numbers are still high, supply chain bottlenecks have eased considerably. Housing price increases have started to level off, and gasoline has declined in the US for 69 days in a row*. As inflation numbers improve, the federal reserve interest rate increases will slow down and eventually level out. Elsewhere, the world is learning how to deal (economically speaking) with the Russia/Ukraine conflict, and commodity prices have dropped from their highs in March. Strong employment numbers continue, and GDP growth will eventually turn positive again.
The S&P 500 and Barclays US Aggregate Bond Index posted their best monthly returns for this year in July. While we hope we have already seen the bottom of this downturn, we are confident that there will be a recovery as economic data continues to show improvement.
*As of August 22, 2022, according to Federal Reserve Economic Data.
The foregoing content reflects the opinions of Highland Financial Advisors, LLC, and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions, or forecasts provided herein will prove to be correct.
Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns.
Securities investing involves risk, including the potential for loss of principal. There is no assurance that any investment plan or strategy will be successful or that markets will act as they have in the past.
Sean Gallagher is a CERTIFIED FINANCIAL PLANNER™ at HIGHLAND Financial Advisors, a Fee-Only financial planning firm that offers comprehensive financial planning, retirement planning, and investment management. Sean graduated from Virginia Tech’s financial planning program in 2018 and successfully passed the CFP® national exam in 2019. As a Financial Planner at HIGHLAND Financial Advisors, Sean works on developing comprehensive financial plans and investment management for all clients.