A Silver Lining

“Everyone has the brainpower to make money in stocks. Not everyone has the stomach.”

-Peter Lynch, Former Fidelity Magellan Fund Manager

During these tumultuous months, it is almost impossible to avoid commentary about the economy and markets. Still, reviewing a historical perspective is helpful when evaluating appropriate strategies. A market correction is defined as a decline in the respective market indices of between ten and twenty percent from the most recent peak. A bear market is identified as a decline of more than twenty percent in the value of an index from its most recent high-water mark. Since the end of World War II until 2020, there have been twelve bear markets in the United States.

Historically, the S&P 500 has never failed to recoup the losses incurred during these challenging periods. The average duration of those twelve bear markets is 367 days. The longest lasted 929 days in 2000- 2002. The shortest was just 33 days in the spring of 2020, at the commencement of the COVID-19 pandemic. The average percentage decline from the peak to the trough was 33.6 percent. However, the average gain over the twelve months following the trough was 40.8 percent. While this cannot guarantee the future, it takes around 22 months to recover entirely from the damage caused by previous bear markets. Finally, the industry defines the bear and bull markets by how these intimidating animals hunt and fight their prey: A bear hunts its prey by standing tall and attacking in a downward direction, while a bull attacks by hunching low and projecting upward.

As of September 30, 2022, the current bear market has lasted 270 days, and counting. The S&P 500 has declined by 25.25 percent from its all-time closing high, which occurred on January 3, 2022.

A proper and more extended perspective for today’s current investing environment requires a deeper historical context since the calendar year 2019:

2019: This was a relatively normal economic and market year around the globe with no significant upheavals or problematic imbalances created. The U.S. Stock Market, as measured by the S&P 500, produced a total return of 28.9 percent, and a one-year certificate of deposit yielded 1.9 percent. The consumer price index (CPI), the prominently used economic index that measures inflation, averaged 2.3 percent. Balanced portfolios averaged 22.6 percent, as defined by approximately 40 percent fixedincome/60 percent equities.

2020: It was a routine start to the year until spring when the COVID-19 pandemic shut down societies and the world economy. The global financial markets descended into tailspins in mid-March, and we witnessed the most rapid bear market decline in history. However, as previously stated, we also experienced the most rapid recovery from a bear market, with the entire “round trip” occurring over approximately six weeks. The CPI was cut to 1.2 percent, as both business and consumer demand was virtually extinguished. The Federal Reserve Board immediately cut interest rates and flooded the economy with liquidity, reducing government bond yields to slightly under .5 percent. The one-year bank certificate of deposit yielded a meager 0.2 percent. In fact, during one volatile trading session, the price for a barrel of oil actually went negative. In other words, sellers paid the buyers to take a barrel of oil off their hands. Despite this extreme market volatility and because of an incredible amount of excess liquidity infused into the system by central banks around the world, the S&P 500 produced a total return of 16.3 percent. Balanced portfolios, as defined above, produced total returns that year of 15.3 percent. Finally, to complicate matters during challenging and exhausting times, we also experienced social unrest and rioting throughout the summer months in the United States, and a bitterly contested presidential election.

2021: After starting the year with the January 6th riots at our nation’s Capitol, 2021 can be best defined by “fits and starts.” For that matter, the country and the world were figuring out how to deal with the ongoing threat of COVID-19. The vitriolic political undertones created even more worldwide political and social disunities. However, a remarkable feat was accomplished by corporations as they dealt with the pandemic by cutting costs and producing eye-popping earning results. The CPI began to escalate as inflation became increasingly embedded within the global economy and averaged 7.2 percent in the United States during the year. Most importantly, the trajectory moved upward for inflation as the Biden administration and Congress continued developing and passing legislation for additional economic stimulus, throwing another match on the already burning inflation fire. Despite obvious signs that inflation was not transitory, the Federal Reserve Board continued injecting monetary stimulus and kept interest rates hovering around zero percent. As a result, there was no alternative for investing allocations (a one-year bank certificate of deposit provided a yield of 0.1 percent) except stocks, and the S&P 500 produced total returns during the year of 26.9 percent. Balanced portfolios produced total returns of 15.3 percent.

2022: The start to this new year was much calmer than the previous two, but we were beginning to understand the impact of inflation and its textbook definition: “Too much money chasing too few goods and services.”

Source: Bureau of Labor Statistics, FactSet, Federal Reserve Bank of Philadelphia, University of Michigan, J.P. Morgan Asset Management. Contributions mirror the BLS methodology on Table 7 of the CPI report. Values may not sum to headline CPI figures due to rounding and underlying calculations. “Shelter” includes owners equivalent rent and rent of primary residence. “Other” primarily reflects household furnishings, apparel, education and communication services, medical care services, and other personal services.

The supply chain issues that began in 2021 continued to be problematic in early 2022, and the Federal Reserve Board began to raise interest rates and ceased buying government bonds in the spring. Russian president, Vladimir Putin, decided to invade Ukraine, and economic imbalances have significantly plagued Europe and spilled over worldwide. Here in the United States, we have gone from virtually zero percent interest rates to currently 3.75 to 4.00 percent with the expectation that the terminal federal funds rate will reach 4.5 to 5.0 percent before the Federal Reserve pivots and ceases raising rates. Thirty-year fixed mortgage rates have more than doubled in just the past nine months to 7.2 percent, which has cratered the housing market. The consumer price index measure of inflation possibly peaked in June this year at over 9.0 percent, but has been stubborn in its decline. Thus far, we have experienced three consecutive quarters of declines in the United States and most global stock markets, and continue flirting around the bear market milestone of a twenty percent plus decline from the most recent peak.

In light of all these unprecedented and historical events of the past three years, balanced portfolios have sustained positive total returns! While this is no guarantee of future performance, and the year-to-date results are quite dismal, we remain diligent with our asset allocation strategies, comfortable with our investment and management selections, and continue proactively planning for our clients. We are estimating that the fourth quarter will present some additional challenges as inflation remains stubbornly high. OPEC+ recently cut their oil production by over two million barrels per day and the Federal Reserve continues with its stated commitment to monetary tightening. In addition, the geopolitical wildcard remains with President Putin in Russia. He is becoming increasingly cornered as Ukraine makes significant positive advances in protecting its homeland. We could be drawn into an unwanted war if he lashes out and targets NATO nations. Europe’s economies continue to experience the direct impact of the war in Ukraine as evidenced by the chaotic appointment and subsequent resignation, after just forty-four days at the helm, of Liz Truss in the United Kingdom. Finally, and to round out the year, the United States has the mid-term elections in a matter of days.

While nobody can accurately predict the bottom of any stock market, we are reminded that the markets, consisting of bonds, stocks, and alternatives, are discounting mechanisms that tend to forecast events six to twelve months into the future. While we perceive that the United States is, if not already, close to being in a recession, we are planning for a relatively shallow decline in near-term economic growth. However, this recession is projected to last slightly longer than usual, perhaps into the second quarter of 2023. Therefore, if history repeats itself, the global financial markets will have reached bottom long before a recession is declared. Finally, this recession is driven by inflationary and interestrate imbalances and in no way resembles the previous few harsh recessions that occurred in 2000-2002, 2008-2009, and 2020.

Despite all the perceived and actual risks, we are encouraged and envision a silver lining that monetary and fiscal policies globally are returning to normal. In other words, it is NOT normal for interest rates to be stuck at zero and negative in some countries. This creates tremendous economic and market imbalances, contributing to what we are dealing with today. However, IT IS normal for interest rates to hover between 4 to 6 percent, allowing savers to prosper once again and investment allocations to be more balanced and logical. Market participants and traders can no longer depend on the global central banks to rescue them during market downdrafts, which manages and dilutes future excessive risktaking. We have been and will continue to adapt our clients’ portfolios to this new environment, trusting the end result to prove positive over the long term. Unfortunately, we must experience a painful transition before more positive economic and investment environments evolve.

Thank you for your trust and loyalty, especially during these challenging days. We covet your prayers for wisdom as we take seriously our responsibility to be good stewards of your hard-earned investment dollars.

Sources: Robert F. Carey, Chief Market Strategist, First Trust

Bureau of Labor Statistics, Wall Street Journal, JP Morgan Guide to the Markets

S&P Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. The performance of an index is not illustrative of any particular investment, and the performance figures quoted are historical. It is not possible to invest directly in an index. This material may contain an assessment of the market environment at a specific point in time. It may also contain forward-looking statements regarding future events or future financial conditions. Actual events or conditions may differ materially from those expressed in this material. These statements are based on our current beliefs or expectations and are subject to uncertainties and changes in circumstances, many of which are beyond our control. The readers should not rely on this information as research or investment advice, nor should it be construed as a recommendation to purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and, when redeemed, may be worth more or less than when originally invested.