It never ceases to amaze me how difficult it is to accurately forecast the future direction of financial markets. The first half of 2022 was challenging for investors to say the least. By mid-June, the war in Europe, fears of recession, the highest inflation in 40 years, record low consumer sentiment, record high gasoline prices, and rising interest rates—and the threat of still steeper rate hikes to come—all offered little hope for a brighter future. By June 15, U.S. stocks and bonds had declined 21% and 12% for the year, respectively.1 The future looked dire. Many investors questioned the wisdom of continuing to own stocks and bonds given the deteriorating economy, high inflation, and rising rates.
The economic picture hasn’t improved much since. As of mid-June, the U.S. Federal Reserve hiked interest rates 0.75%, first on June 16 and again on July 27—the steepest rate hikes since the early 1990s. Further, on July 28 the Bureau of Economic Analysis reported that second quarter GDP fell 0.9%, following a 1.6% decline in the first quarter.2 One could be forgiven for thinking that such bleak economic news would’ve led to further YTD declines for U.S. stocks and bonds. However, rarely is the connection between the economy and financial markets so simplistic and linear. Contrary to what one might’ve expected, from June 15 to August 15, U.S. stocks returned 16% and U.S. bonds returned 4.5%, despite two blistering rate hikes.3 Through August 15, U.S. stocks were down 9.7% for the year and U.S. bonds were down 8.7%.4 While markets are still broadly negative for the year, the market rally of the past two months turned what was a bear market in stocks (defined as a greater than 20% decline) into something less than a mild correction (defined as a decline of 10% – 20%).
These lessons may sound familiar but are worth repeating. First, we should be careful not to make long-term investment decisions based on short-term data—and economic data is almost always short-term; it’s constantly changing. If you don’t like what you see, give it a quarter or two—it’s likely to change. Second, while virtually all economic data is backward looking, financial markets are forward-looking. The purpose of markets isn’t to obsess over historical data (it’s already in the price) but to digest and assess whether and how today’s new information might impact the future—not just next month, next year, or even the next few years, but for many years to come. Finally, there is wisdom in humility. And the best way to incorporate humility into your portfolio is to resist market timing, fad investment trends, or making highly concentrated bets on individual stocks or asset classes. Despite a difficult year, diversification and patient, long-term investing continue to be our best friends.
1 YCharts, Inc.; Data is for Russell 3000 and Barclays U.S. Aggregate Indices
2 Bureau of Economic Analysis
3 YCharts, Inc: Data is for Russell 3000 and Barclays U.S. Aggregate Indices
4 YCharts, Inc: Data is for Russell 3000 and Barclays U.S. Aggregate Indices
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