It’s been a historic start to the year for both stock and bond markets -unfortunately, not in a good way. As of market close on Friday, May 6th, the S&P 500 Index fell -13.49% year to date and the overall bond market which is reflected by the Barclays U.S. Aggregate Bond Index is down -10.51% year to date.
Bonds which have historically provided support to portfolio allocations during times of stocks market selloffs have done little to protect portfolios. Generally, the bond market is inversely correlated to the stock market and bonds have not done their job as a portfolio ballast this year. Negative performance for both the bond and stock market simultaneously is truly rare. It’s so rare, that it has only happened three times since 1928 and the most recent period was in 1969 (ending year total return).
The concerns that have contributed to the market’s poor start to the year are well-known. Historically high inflation, continued supply chains disruptions, China’s Zero Covid Policy and continued lockdowns of major manufacturing cities, geopolitical concerns, an aggressive Federal Reserve rate hiking campaign, and soaring bond yields have all contributed to the worries.
Any one of these issues can be problematic for stock and bond markets but all six of these issues occurring at once is unprecedented.
Yet, we remain optimistic (but not naïve), that the 3rd and 4th quarters of the year may bring some much-needed good news. Yes, the first quarter GDP report showed the U.S. economy contracted but that was mainly due to drags on inventory and trade, while more important parts of the economy like consumer spending, housing, and private sector investment all accelerated compared to the fourth quarter.
Additionally, looking back at years 2011 and 2014, both saw negative first quarter GDP prints, followed by big rebounds in the second quarter to avoid recessions -remember, a recession is recognized after two consecutive quarters of negative GDP growth rates. Despite the first quarter, we expect GDP to grow approximately 3% this year and we do not expect the U.S. economy to tip into recession thanks to a strong consumer and continued healthy corporate earnings backdrop.
Furthermore, Inflation could be nearing or has already peaked, offering a potential driver for improved investor confidence in the second half of this year. Used car and truck prices have come down significantly over the past two months, while air and ocean freight shipping costs have also dropped recently but remain high compared to pre-pandemic rates. These two bits of data suggest inflation may be past its peak, even if it may take a while for it to get back to normal. Add in supply chain normalization and the potential for a ceasefire in Ukraine to remove some upward pressure on commodities, the Federal Reserve may not need to hike rates nine more times this year as the bond market is currently pricing in.
On Wednesday (May 11th), the next consumer price index report is released and is likely to show that U.S. consumer prices rose 8% from a year earlier in April, which would make it likely that March’s 8.5% increase was the high for the current cycle. If CPI and PCE reports start to reflect a break in the inflationary fever, it could provide the framework for a year-end recovery rally.
Tactically, regarding portfolio management, we remain overweight to stocks (where appropriate) given the continued challenges posed to bonds in a rising rate environment. For cash on the sidelines that need to be invested, we are dollar cost averaging the funds into portfolio allocations over time on market dips. Unfortunately, “buying the dip” has not worked in this environment as markets continue to decline. Another extremely challenging aspect of the current market is companies that beat earnings expectations and reiterate or increase their forward guidance are not being rewarded and, in most cases, the initial “pop” in their share price is quickly eroded due to indiscriminate selling across sectors.
Given the current environment, we are keeping higher levels of cash within portfolio allocations and believe the market needs to see evidence of inflation subsiding before we can get a true recovery rally. Unfortunately, the recent rallies have proven to be head fakes or an oversold bounce that quickly evaporates.
Yes, this market stinks. It’s not fun and it’s unsettling (even for us). Sometimes the best thing to do is nothing, sit on your hands and hunker down until the storm clouds pass and we can get some clarity on the issues mentioned above. We have been here before and very rarely (if ever) does it pay to try and time the market bottom by jumping in and out.
Please remember, as I mentioned in March’s note. We’re not investing for the next 6 months but for the next 5 to 10 years and beyond. It’s imperative to remember your true investment time horizon during market corrections and we urge patience.
Please know, markets will recover -they always do.
As always, please reach out to us with any questions or comments you may have regarding your specific situation.
Jaran C. Day, Chief Investment Officer
Griffin Dalrymple, CFP®, Chief Strategy Officer