It has been a rocky year. A jump in inflation sent shocks through the bond market, and worries over the ill-effects of inflation fighting spurred a selloff in stocks. It’s as if the economy is too hot and too cold at the same time. As a result, long-term interest rates are at the highest levels since 2018, and the S&P 500 briefly fell 20% below its January 3rd peak.
With the market down, inflation up, and a nuke-carrying Russia engaged in a land war, it’s no surprise investors are feeling down right now. According to the American Association of Individual Investors at the end of May, less than 20% of investors surveyed felt bullish on the stock market – the lowest reading since 2005. In contrast, 53% of investors surveyed felt bearish.
The pain has been especially sharp in speculative financial assets. This year, shares of the once-hot stocks investors clamored for in 2020 and 2021 have seen share prices collapse. Shares in some young technology companies have fallen 80% from their highs. Pain in cryptocurrencies and their derivatives continued as bitcoin fell below $30,000 and is down 56% from last year’s high. The collapse of so-called stablecoins, designed to maintain a stable value of near $1, is a reminder that seemingly unfathomable risks abound in this new, unregulated wild west.
Less exciting areas of the market have helped diversify declines in the technology sector. Shares of companies domiciled in Europe, Japan, and emerging markets have held up better than US stocks.
The bond market shows some signs of stabilization. Inflation worries may be waning as the bonds recovered from recent lows. The yield on the 10-year Treasury touched 3.13% in May but finished the month with a yield of 2.84%.
Recession … Eventually?
The concern is that the Federal Reserve will tighten monetary policy to combat inflation, but in so doing, will strangle the economy.
For the Fed, the challenge is to thread this needle. Slowing inflation without overshooting has been difficult to finesse historically. The Fed’s strategy is to move soon while the economy has momentum and before higher inflation becomes entrenched in expectations. Right now, surveys of consumers and market-implied inflation expectations remain anchored below current inflation, offering hope that the Fed is not too late. Also, there are signs that inflation pressures are already softening.
Many prognosticators are forecasting an imminent recession. However, it is far from a foregone conclusion, and the stock market is already anticipating some degree of a recession. The economy will eventually contract, but shouting that a recession is coming does little more than grab attention, headlines, and clicks online. Without details on the timing, the severity, or the extent it’s baked into today’s stock prices, this is of little value. One thing is for sure, if the recession does happen, nearly everyone will have seen it coming!
Despite the pessimism, the economy is starting from a strong place and continues to face the challenge of labor shortages. This is not the marker of a weakening economy.
What to Do in a Bear Market
Keeping the faith in your plan and investment strategy can be challenging when the market hits a rough patch. While there are many things you should not do during downturns, we are evaluating our client’s situations and looking for the following opportunities:
Tax-loss harvesting. In recent months, we have been actively tax-loss harvesting taxable investment accounts. This means that we sell tax lots with capital losses and reinvest the proceeds in similar but not “substantially identical” securities. Reducing capital gains is part of a tax efficient investing process. Exactly how it affects each client depends on their own unique circumstances.
Roth conversions. 2022 may be a good year to convert money held in traditional IRA assets into a Roth IRA. If you expect to be in a higher tax bracket in the future, it could be a good time to pay the tax and reposition some retirement assets for tax free growth in a Roth IRA. With recent changes to rules on inheriting IRAs, this could also potentially benefit heirs too.
Avoid attempts at timing the market. Few can claim to do it successfully. The costs of unsuccessful attempts can derail a solid investment plan. As we wrote last month, in times of volatility, big declines are often followed by big reversals. Fortunately, timing the market isn’t required for long-term success.
What It All Means
Swings in the stock market are part of the normal course of investing. The performance this year is shaping up to be one of the worst starts for stocks and bonds on record. The arbitrariness of the calendar year may overstate the rarity of this performance. Looking back at other five-month windows of time suggests the performance, while well below average, occurs every so often.
Every challenging time has its own uniqueness, but we have been through uncomfortable times before. In 2020, a health crisis not seen in 100 years disrupted our daily lives. In 2008, the near collapse of the financial system threatened to change the economy forever. Yet, only in hindsight, did civilization find a path forward. Investors who stayed the course also survived.
Let us know if you would like to discuss your financial situation.
Contact us at 865-584-1850 or info@proffittgoodson.com