Financial markets remained volatile in the second quarter of 2022, while inflation reached four-decade highs and concerns grew that inflation fighting efforts might tip the economy into a recession.
Regarding the possibility of a recession, some context is also in order. There is an old joke that goes like this:
Q: What’s the difference between a recession and a depression?
A: A recession is when your neighbor loses their job. A depression is when you lose yours.
Losing a job is no laughing matter, but the quip is intended to highlight the fact that economic slowdowns effect people disproportionately. For someone that loses their job or is in a heavily impacted industry or geography, a recession can be catastrophic. But consider that with the exception of the COVID lockdowns in 2020, the last eight recessions dating back to 19601 have seen the economy dip an average of 2.1%. That’s equivalent to a person who eats out two times a week eating at home one extra time every six months. Or a person staying in a hotel one less night over the course of a year. Or buying one less box of cereal on their weekly trip to the food store.
So yes, recessions can be catastrophic to some, and they are frightening to most. But the reality is that even though the news might lead you to believe otherwise, the actual impact of a recession is often relatively muted.
Shifting to markets, it’s important to remember that the stock market is a leading indicator. In other words, stock prices generally sell off ahead of a recession. That means that even if we enter a recession, it is possible that stocks may have already experienced most or even all of their declines. They may even begin moving higher by the time we “know” we are in a recession.
With that in mind, we think that it is also important to remember that market volatility is a normal part of the investor experience. In fact, there have been 28 stock bear markets in the last 95 years, which means that the type of stock market decline we are currently experiencing typically occurs once every three and a half years. In other words, it isn’t the current volatility that is unusual, but rather the remarkably smooth upward run we’ve enjoyed since 2009 (with the very notable but short-lived exception of the 2020 COVID-blip.)
The sell-off in bonds is a little different because its magnitude is several times greater than what we have previously experienced. However, starting yield is a key determinant of future bond market returns, so the increase in the 10-year Treasury yield from 1.50% to around 3.00% means that investors will receive more income in the future. That doesn’t mean bond prices can’t continue to decline, but it does mean that if you have a long-term time horizon, your bond portfolio is in a far better place today than it would have been if rates hadn’t increased.
With the highest inflation since the 1970s, soaring gas prices, declining stock markets, and recession worries, it’s not surprising that consumer confidence is falling, with the University of Michigan Consumer Sentiment Index recording a record low in June. Keep in mind though, that stocks are often the most attractive when the outlook is gloomiest.
J.P. Morgan2 analyzed stock market returns following eight previous consumer sentiment peaks and eight previous troughs. What they found was that buying stocks when sentiment peaked yielded average returns of just over four percent the following twelve months. But buying stocks when sentiment troughed produced average returns of nearly 25% in the year ahead! Those statistics reinforce the importance of staying the course or even adding to stock holdings when prices are down.
So besides staying the course, what should you do in this environment? For starters, make sure that your asset allocation reflects your real risk tolerance, and if you have doubts, talk to your financial advisor. Looking at the impact of recent declines on your cash flow and retirement planning can provide confidence in your overall plan and portfolio.
You can also focus on making the most of a difficult market environment. For instance, if you have been considering Roth conversions, perhaps it makes sense to accelerate the timing or increase the size of the conversion, in order to convert more shares while prices are down. Similarly, by tax-loss harvesting in non-qualified accounts, you can position yourself for a more tax-efficient future.
Remember, it was only a little over two years ago that most of us were sheltered in our homes, unable to live normal lives as COVID shut down the economy and cratered stock markets. Since that time, we have had a contentious presidential election, turmoil in the Capitol, a war in Europe, and record high inflation. Against that backdrop the S&P 500 is up more than 60%, which is a powerful reminder about the long term potential of investing in stocks regardless of the news cycle.
Data as of June 2022
Intended for educational purposes only. Opinions expressed are not intended as investment advice or to predict future performance. Past performance does not guarantee future results. Consult your financial professional before making any investment decisions. Opinions expressed are subject to change without notice.