Bear markets are when stocks are returned to their rightful owners”
“You make most of your money in a bear market; you just don’t realize it at the time”
Value Investor Shelby Davis
With the benchmark S&P 500 index down 22% year-to-date and 23% from its high, we are officially in a bear market. The Nasdaq Composite, with heavy exposure to technology companies, is down even further, about 31%. Small cap stocks, represented by the Russell 2000 index, are down 23%. So what are investors to make of all this and how should we respond to this understandably scary situation? First, let’s pause, take a breath and refer to previous bear markets to gain some historical perspective.
Today, June 17th, the S&P 500 index is trading at 3,690, roughly the same level we were approximately 17 months ago in January of 2021. With the constant drumbeat of negativity from the media – especially the so-called financial media – one might think that years of market gains have been obliterated and that the magnitude of this decline is nothing less than catastrophic and unprecedented. That narrative might draw readers and viewers but it’s untrue and, frankly, disingenuous. While none of us can predict the future, all of us can learn from the past. History tells us this economic contraction/recession or whatever we prefer to call it, and the bear market we are in, are fairly typical of previous bear markets and will end at some point in the not too distant future, probably within the next few quarters. And unless this bear market is different than every other bear market of the past century, it will be followed by the next economic expansion and resulting bull market. Will a recession occur this year or next and if we do have one, will it be mild or severe? No one – not even the Federal Reserve – can answer that question with any certainty. What we do know is that the market has already priced in a recession that is either weeks or months away or is already here. In the past stock prices have declined well in advance of actual recessions and then began rising well before the recession showed signs of ending. This dynamic has happened numerous times since World War II, through different political administrations, interest rate cycles, through budget deficits and surpluses, through tax increases and tax cuts, in periods of high inflation and low inflation, through wars and almost every other scenario one can imagine. And it will probably happen again this time.
Stocks, Bonds, Yields and Inflation
The pullback in stock prices this year isn’t terribly surprising given that the S&P 500 index posted a 26% average annualized compound return over the past three years. In fact, one can argue that a pullback of some degree was needed to bring valuations back in line and avoid a dramatically overvalued market such as the one we experienced in the late 1990s, that led to 3 years of consecutive negative returns in the early 2000s. While unpleasant, temporary losses of 20% to 25% in stocks occurs every few years. In contrast, the dramatic decline in bond prices this year due to sharply rising yields caught many investors off guard, not because interest rates are rising but because of the velocity and magnitude of the increases. Consider that the yield on the benchmark 10 year Treasury note has increased from 1.7% on January 1st to above 3.3% in just over 5 months, a move of historic proportions that almost no one on Wall Street called in terms of magnitude. This sharp rise resulted in the Barclays Aggregate Bond index posting a year-to-date return of -12%, the worst return for the bonds in over 40 years. Additionally, stocks and bonds have both posted negative returns this year, a situation that’s occurred only 4 times previously and none of those were as severe as this year. This unusual situation made diversification less effective this year than it would be during a “normal” year.
In summary, while we can’t predict the future, history can provide us with guidance about what we can likely expect in the future. These are our thoughts:
- Inflation will eventually slow from a combination of Fed tightening, slower growth and improvements in the supply chain and stocks will benefit as a result. Lest we forget, the classical definition of inflation is “too many dollars chasing too few goods”. If the money supply shrinks and the velocity of money circulating through the economy declines (due to less spending and borrowing by both companies and consumers) at the same time the supply of available goods and services increases, inflation should meaningfully decline. While impossible to predict with any accuracy, a decline from 8.6% to perhaps the mid 6% range by year end or Q1 2023 seems reasonable with further declines to perhaps 4% or less by the end of 2023 very possible. Note: from an investment perspective the actual figures are less important than making progress directionally, which increases both consumer and investor confidence.
- Investors will eventually decide, at some price level, that the underlying intrinsic value of companies, the dividend yields produced by their stocks and their future growth prospects are not being reflected in current share prices, When that happens investors will step in and buy stocks. This is the natural bull/bear/bull market cycle.
- Interest rates will eventually level off and stabilize, as will bond yields. When this happens, the yields being produced by bonds and their relative price stability will once again make them attractive to investors on a total return basis.
- After stock prices have declined the risk of investing in equities, in most cases, is significantly lower than it was prior to the decline. Most of us realize that “buying stocks on sale” during a bear market is an intelligent and rational decision but find it emotionally difficult to do so when the preponderance of the news is negative. While bear markets happen every few years – and the headline news is always bad during bear markets – every bear market in history eventually ended and stocks resumed their inevitable march higher, fueled by economic expansion and higher corporate earnings. While individual stocks can become worthless, equity indices have never gone to zero. Ask yourself – if you had a time machine and could travel to the past, would you prefer to buy stocks during bull markets when they were relatively expensive or during bear markets when they were relatively cheap?
- Since 1945 the S&P 500 index has declined 20% or more in a calendar year only 3 times – in 1974, 2002 and 2008 (remember we’re only half way through 2022 and a lot can change in 6 months).
- During the years the index lost 20% or more, the average annual total return (including dividends) over the next three years was 7.8%, 14.6% and 14.3% (simple, non-compounded). Will the same thing happen this time if we end 2022 down 20% or more? No one knows but, historically speaking, the odds are on our side. How about years when the index had a loss of any magnitude, not just 20% or more? Since 1945, out of 76 years the index experienced a loss in 15 of those years. Below is what happened in the 3 years following those 15 down years:
- The average annualized non-compound return was 14.3%.
- The median annualized non-compound return was 14.6%.
- The best average return was 25.9% from 2019 through 2021.The worst average annual return since 1945 was – 5.5% from 2001 through 2003 when S&P returns were negative for three consecutive years, 2000 through 2002, the only time this ever occurred.
In summary, stocks are intended as multi-year investments and should be used as such. The average annual total return for equities of around 10% over the past 100 years required living through numerous bear markets just like the one we’re in today, and some that were far worse. Whether you’re age 35 or age 80, depending on your circumstances, there’s likely a good case for having a portion of your investment assets in stocks with the understanding that doing so requires a minimum time horizon of 5 to 7 years, meaning a full market cycle. If price declines like we’re experiencing today that are likely temporary are causing you an inordinate amount of stress, we should probably have a discussion.
In closing, the most important contributing factors to long term investing success is time and discipline. Patience through all market conditions –especially during market downturns – is paramount for success. The equity market provides a highly effective way of compounding wealth over time, as well as enjoying rising dividend income, as long as we don’t interrupt the process. Our job is to help make sure that doesn’t happen to you.
Please feel free to call us at any time with questions, comments or concerns. Have a great week and, as always, thank you for your trust, your confidence and your business.
W. Edward Sutton
President and Chief Investment Officer
The Sutton Wealth Advisors Investment Committee
Zachary Sutton CFP®, EA
Matt Bertoncini CFA
Sutton Wealth Advisors, Inc.
3708 West Swann Avenue, Suite 102
Tampa, FL 33609
Tel: (813) 514-1800
Fax: (813) 514-1877
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The information contained herein (1) is intended solely for informational purposes; (2) is not warranted to be accurate, complete, or timely; and (3) does not constitute investment advice of any kind. Neither Sutton Wealth Advisors, Inc. nor Purshe Kaplan Sterling Investments is responsible for any damages or losses arising from any use of this information. Past performance is not a guarantee of future results.
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