Clearly 2022 has been a tough time for investors and people are understandably nervous and even frightened. Before we get into the FAQs below we should remember that market bottoms – not market tops – are typically associated with the high levels of fear and pessimism we’re seeing today. As always, patience is the long-term investor’s best friend. I hope you find this article, which should take 8 minutes or less to read, interesting and helpful. As always, feel free to call us at any time.

Why Are Stock Prices Down This Year?

After three years of very strong performance from stocks, with the S&P 500 index averaging 26% annually from 2019 through 2021, if 2022 ends up being a negative year, it won’t be surprising. Stocks typically experience negative returns about 20% of the time. In spite of these temporary setbacks, stocks have also proven to be the best method of accumulating wealth, preserving purchasing power and generating increasing income over time through rising dividends. The selling today is due primarily to concerns over rising interest rates, supply chain issues, higher than expected inflation and slowing economic growth, at least compared to last year’s huge numbers. While these are real concerns, we think they’ll prove to be temporary and that investors will be rewarded, as they’ve been in the past, for staying the course and remaining committed to a long-term view.

Is the Magnitude of This Decline Alarming?

No, not really. While market declines are always unnerving when you’re living through them, they’re also a normal part of the equity investing process. At this writing the S&P 500 is down about 15.9% from its December 31st closing price and 16.4% from its highest point in early January. Interestingly, the average decline for the S&P 500 from peak to trough over the past 42 years (since 1980) is about 15%, meaning this decline is barely above average in terms of severity, although it probably feels far worse than that. We need to remember that investors who rode through these volatile intra-year swings over the past 4 decades have enjoyed average annualized total returns of just under 10%.

Bonds Have Lost Quite A Bit of Their Value This Year. Aren’t Bonds Supposed to Perform Well When Stock Prices Are Declining?

While stocks and bonds usually move in opposite directions, that’s not always the case. This year through early May U.S. stocks and bonds have both experienced double-digit negative returns. Only 4 times since 1930 have stocks and bonds both suffered losses in the same year and two of those years were before World War II. The primary cause of lower bond prices this year is rising interest rates initiated by the Federal Reserve to reduce inflation. At some point we expect stocks and bonds to “decouple” and resume an inverse relationship, although this might not happen until the Fed is no longer raising rates. Fortunately, investors today have ways to diversify their portfolios other than owning just stocks and bonds, including alternative assets. Adding alternatives to a portfolio may reduce portfolio volatility and enhance investment returns versus owning only equities and bonds. Reducing bond exposure in favor of alternatives, which is what we’ve done at SWA, might also reduce a portfolio’s sensitivity to interest rates. Alternatives include: private equity, private credit, convertible arbitrage funds, managed futures, hedged equity, commodities, real estate, etc.

Is a Recession This Year Likely?

We don’t think so but there’s no sure way to predict recessions which are typically defined as two consecutive quarters of negative GDP growth. Although GDP was -1.4% in Q1, this was mostly due to a surge in imports as businesses rebuild depleted inventories and from declines in government spending. Other economic metrics in Q1 were strong, including consumption as Americans generally have strong balance sheets, ample savings and higher incomes. Even with high levels of inflation consumers are spending robustly, especially on travel. Since consumer spending is 70% of our economy and corporate earnings have been strong this year (still expected to grow 8% to 10% in 2022 year over year, even with inflation), we think a recession this year is a low probability. Frankly, even if we do experience a recession, stock prices tend to decline well before an actual recession is confirmed and start to recover well before the end of recession is in sight. To be clear, whether we do or do not experience recession this year or in 2023 should not impact an investor’s decision to own equities as long-term investments, long term meaning a minimum of 5 to 7 years and hopefully longer.

Are Stocks Still “Too Expensive” Even After the Sell Off?

That depends. Stocks that benefited from the “stay at home-pandemic” thesis, companies like Peloton, Teledoc, DocuSign, Twilio and many others that soared in value in 2020, have seen their stock prices fall precipitously. Many of these companies are trading 75% below their all- time highs and, in the opinion of many analysts, are still overvalued. These companies were trading at unsustainably high earnings multiples and, in some cases where there was little or no profit, on multiples of sales revenue. At the same time many other well-established companies with strong balance sheets, high sustainable free cash flow, attractive dividend yields, stable profit margins, quality managements and reasonable valuations are down far less the pandemic stocks, with some stocks in positive territory. A significant number of companies in the S&P 500 plan to buy back billions of their outstanding shares. Analysts expect buy backs this year to exceed $1 trillion, well above last year’s figure. Whether stocks decline further before bottoming and resuming their 100 year plus long-term upward trend, or if the decline is about over, the good news is that investors who remain focused on the long term should be fine. As to investing new cash, historically investors have not had to buy at the “bottom” to earn attractive after-tax, after-inflation total returns (dividends plus appreciation) from stocks over a multi-year time frame. Much more money has been lost by people moving to or sitting in cash trying to avoid temporary losses than has been lost by staying invested in equities and riding through market cycles, including bear markets. Please refer to the attached chart, courtesy of First Trust, for an overview of past bull/bear market cycles. The lessons of the past, reflected on this chart, provide a compelling case to remain patient and disciplined, especially during challenging investing conditions.

Can We, and Should We, Be Optimistic About the Future?

After almost 40 years as a professional investor I believe the only rationale answer to that question is yes, and this is why. We have a century of investing history to refer to for guidance during past market cycles. Although the past is never a guarantee of future events or results, this is our expectation over the next few quarters:

  • Inflation will eventually decline and supply chain issues will eventually improve.
  • Stock prices will stabilize, stock valuations will be considered attractive and investors will re-allocate some of the $5 trillion of cash on the sidelines into equities.
  • Companies will use their large cash balances ($1.9 trillion for S&P 500 companies) to buy back stock, increase dividends, make capital expenditures to organically grow their businesses or pursue mergers & acquisition opportunities. All of these options are good for shareholders.
  • Interest rates will stabilize as will bond values.
  • Investors who remain patient and stick to their long-term investment plan will be rewarded appropriately while investors who abandon equities out of fear or trying to time the market will forgo the opportunity to compound and grow their assets over time.

Last, I’ll refer once again to the chart from First Trust. This chart should tell you all you need to know about how to navigate volatile markets. None of us wants to be the person who, in retrospect, sold stocks during a market downturn only to miss the bull market recovery that has eventually followed every bear market of the past 100 years.

Please feel free to reach out to either Ed, Zack, Bill or Matt if you have any questions, if you’d like any additional information or if you’d like to discuss your portfolio or the markets in general; that’s why we’re here. 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

W. Edward Sutton, Zachary Sutton CFP®, EA Matt Bertoncini CFA