The first half of 2022 has been the worst for stocks since 1970. Inflation has been the primary culprit in the poor performance in stocks, and even worse performance in bonds during the first quarter. In the second quarter the carnage escalated for stocks and even commodities (one of the few winners this year) sold off from its highs as investors worried about a global economic slowdown and recession.
The stock market volatility has been at extremes not seen since 1928. Investor sentiment has recorded the lowest numbers since University of Michigan started tracking investor confidence. These types of facts are usually seen nearer to Bear market bottoms. Unfortunately, we are still seeing a lack of upside potential in stocks, even from current depressed valuations. This does not mean that there will not be rallies within a bear market, it also does not mean that there are no places to make money in the current environment. What it does mean is that investors need to be disciplined, and as we wrote going into the new year, do not follow the herd. Here’s what we wrote in our 4th quarter report 6 months ago:
The year 2021 transpired much as what we expected. Most stocks did extremely well, with the S&P 500 surging 27% for the year, marking the third consecutive year of gains over 18%. In comparison, bonds performed poorly, with long-term treasuries actually declining over 4% for the year with most bonds categories losing principal with the exception of municipals and the high yield or junk bond arena, which showed modest positive returns. These macro results corresponded with our dynamic pivot over the past two years to own real assets and to avoid (or minimize exposure) to bonds, particularly those long-term fixed income type investments. Investors that continued with a 60:40 stocks to bonds allocation were once again disappointed with the bond component. More importantly, as interest rates rise the negative impact on bonds will only become more significant.
Over the next several years there has never been a more crucial time to own the right assets and not adhere to conventional investing methodology. Just like bonds will be vulnerable to higher risk (for their paltry yield) than the average investor realizes, we believe the days of solid double digit percentage returns in stocks are numbered. While select stocks still can offer attractive returns, we believe it will be more challenging and volatile along the way. Jan. 2, 2022
What investors should still realize:
- Be very selective and realize that in this environment traditional valuation measures and investment strategies will not be the primary driver of performance, in other words they will not work.
- Be nimble and lock in profits when you are fortunate to experience such, and only accumulate quality into those panic selling periods
- Make sure to have significant cash in place to lessen the impact of a broad sell-off. This is the same strategy we focused on going into 2022 when valuations were still near all time highs. It really helped our clients during similar periods like the 2008 Global Financial Crisis and the late 1990’s burst dot-com bubble.
Most importantly, in a rising interest rate and high inflationary environment investors should not rely on passive and 60:40 stock to bond allocations that have been so successful in the past. These traditional approaches will be some of the most disappointing strategies for investors now that the speculative side, like crypto and no earning tech stocks have already collapsed in price.
There are some positive shoots starting to sprout, like battered Chinese stocks stabilizing and inflationary pressures dissipating in commodities, for example. But it will take a while, and we would only just start to get in. We are getting closer to a bottom, but there is more pain and volatility ahead, especially for investors that do not know how to position in the current challenging environment. This is one of the key periods when investors are significantly miscalculating risk and, unfortunately it will be most devastating to those that can least afford it.