It’s Been a Tough Year So Far
“If you aren’t willing to own a stock for 10 years, don’t even think about owning it for 10 minutes.” – Warren Buffet, legendary investor and CEO of Berkshire Hathaway
The primary function of financial journalism seems to be terrifying us out of ever achieving our financial goals by shrieking about the market’s volatility. We are being reminded of this daily as some of the major stock indexes are now in “official bear market territory,” which is defined as closing 20% below their previous all-time high. Growth stocks, in particular have suffered the sharpest declines.
Every market decline of this magnitude has its own unique precipitating causes. I think it’s fair to say that the current episode is a response to two issues: severe inflation and the extent to which the economy might be driven into recession by the Federal Reserve’s somewhat belated efforts to root out that inflation by tightening monetary policy. Russia’s war on Ukraine, supply chain issues, China’s Covid lockdowns, and the like have piled on, but recession vs. inflation is the main event in my judgment.
Bonds
If you are in or near retirement, then you should most likely have some bonds in your portfolio. Bonds generally hold up well when stock prices move lower. However, bonds have performed poorly this year, too. According to the Wall Street Journal, bonds are having their worst year since 1842.[1] Yes, that was Eighteen Forty-Two. Interest rates have moved sharply higher this year, and bond prices generally move inversely to interest rates. For many investors, this year feels even worse.
Inflation
Inflation is turning out to be anything but “transitory” – the preferred term used by the Federal Reserve until recently. People generally respond to incentives. And every day that passes, the Federal Reserve is incentivizing people to spend money rather than hold it. Why would you hold money losing purchasing power at 8.5% per year (the rate of inflation) when you are earning next to nothing on it in a savings account? This might work for a while. But without a doubt, something must give here. Either short-term interest rates must rise further (the federal funds rate is .75% to 1.00%)…or inflation needs to come down substantially. And this is precisely what market participants are weighing: will the Federal Reserve significantly increase rates and drive the economy into recession? Or will they tolerate higher inflation for longer? They have a “dual mandate” to achieve stable prices and maximum employment. They are in a tough spot.
Regardless, if we go into recession, then we do. There is clearly excess money in the system. Capitalism is a terrific system that, through recessions, washes away the negative effects of poor decisions by government and private-market participants. We then reset the foundation for firmer economic growth.
Is the News All Bad?
No, it isn’t. In fact, over 90% of companies in the S&P 500 have reported first quarter earnings season, and the results are impressive. According to LPL, 74% of S&P 500 companies beat revenue estimates, 78% beat earnings estimates, revenue grew 13.4%, and earnings grew 9.1%. Obviously, market participants didn’t pay too much attention to these numbers when sending stock prices down, because these numbers are strong. Management teams seem to be figuring out how to work around the myriad labor and supply-chain issues. Without a doubt, some earnings numbers (and estimates) are, to an extent, being artificially increased by inflation. But if earnings and estimates continue to increase, then recession is probably not going to be a near-term event. Therefore, fingers crossed that we’re closer to the bottom of this downturn than the top, but much depends on the Federal Reserve.
Stay the Course
For long-term investors, capitulating to bear markets by selling stocks has generally proven to be a tragedy from which their retirement plans may never recover. Our investment policy is founded on acceptance of the idea that the only way to be reasonably assured of capturing the superior returns of stocks is by riding out their periodic declines. Please remember that since 1980, the average decrease in the S&P 500 is just over 14% in any given year – yet the S&P 500 has been positive in 32 out of those 42 years.[2] You should like those odds. Even the inflationary 1970’s saw the S&P 500 positive in 7 out of 10 years.[3]
My mission continues to give you the best chance of reaching the goals set in your financial plan. And that means staying invested. I cannot insulate you from short to intermediate-term volatility, but I can help you to minimize your long-term regret: the regret that follows from selling your stock positions when they’ve bottomed in price – and then resume their long-term advance, as they always have. I continue to counsel…stay the course.
Are There Any Opportunities in This Mess?
Yes! Roth Conversions – and Roth Conversions. Stock prices are already down substantially, and many people should consider converting funds from a traditional IRA to a Roth IRA – especially for married people whose tax rates are scheduled to remain lower through 2025 under the 2017 Tax Cuts and Jobs Act. When share prices are depressed, you can convert the same number of shares to a Roth IRA for a lower tax cost (due to the lower stock price valuation).[4] Then, ideally, the shares rebound in price inside a Roth IRA, and the funds can later be withdrawn tax-free.
Second, for non-IRA accounts, now is a good time to consider selling some investments that have suffered losses so you can book capital losses that can be used to offset capital gains now and in the future. For the right situations, clients can reap large tax gains by doing this.
Conclusion
I know this has been a painful drawdown in stock and bond prices. And I am acutely aware that it could get worse before it gets better. As always, I’m here to talk through the issues and any anxiety you might be feeling. It is a deep privilege to have earned your confidence and trust. Please stay patient, disciplined, stay invested…and stay focused on the goals in your financial plan.
