Investors face 2 serious headwinds as stocks and bonds perform poorly in 2022
Sometimes stocks do well and bonds underperform. In some years, bonds do well and equities underperform. This year, stocks and bonds have performed poorly. For investors, it is therefore extremely difficult to achieve a positive return. Let’s take a look at the current conditions for these two asset classes and explore what we might expect.
As I wrote in yesterday’s article, “US equities plunge amid worse-than-expected inflation,” equities are facing a serious headwind over the next 6-12 months. With the Fed suppressing the punch bowl through higher interest rates and reduced money supply, coupled with a likely global recession, corporate profits will fall and stock prices may follow. The relevant question is how well will the US economy hold up under these conditions?
We know that corporate earnings, which are currently strong, will likely fall as the Fed continues to cut demand to bring down inflation. If the Fed can thread the needle — that is, it doesn’t squeeze too hard — then the US economy could avoid a more severe economic downturn. However, it is a very delicate dance.
Stock prices are also subject to extreme and irrational movements, especially downwards. We witnessed this yesterday (9/13/2022) as the DOW lost almost 4.0% on the day. This is well above its average daily loss of 0.75%. Tech stocks fared even worse as interest rates rose. So higher volatility remains. The VIX, which measures the expected risk of the S&P 500 over the next 30 days, has been at or above its long-term average throughout 2022. Additionally, while volatility remains elevated, stock prices stocks are under more downward pressure. In other words, when risk is high, stocks tend to underperform.
Although there are many types of bonds, most share a common risk. When interest rates rise, bond prices fall. This year, interest rates have risen significantly across the board, putting strong pressure on bond performance.
Stocks and bonds
Let’s look at the performance of stocks and bonds this year. The following table has three sections including US stocks, foreign stocks and US bonds. All performance data is year-to-date through September 13, 2022. Bond performance is represented by widely traded ETFs as proxies. What does this reveal?
When you compare the three US stock indices, we can say that tech stocks have done significantly worse than non-tech stocks. This is revealed by the NASDAQ
Foreign equities performed slightly better than US equities, but that’s nothing to get excited about, especially as cold weather sets in and Europe faces an energy crisis. Bonds have also fallen this year. The broader US bond market, represented by the first ETF on the list, is down -12.93% so far. High-yield or “junk” bonds are down almost -14.0% since the start of the year. Short-term bonds, a favorite niche for investors since the 2008 financial crisis, are close to balance this year. What can we expect moving forward?
Stocks could face a difficult period, especially if the Fed fails to tighten its actions and if a global recession has a more negative effect on the profits of American companies. Bonds could go either way. For example, if interest rates hold steady or fall, bonds could rise from here. However, if rates continue to rise, bonds will continue to lose. The good news is that we may be closer to the top of interest rates than the bottom, although that is not guaranteed. So what’s an investor to do?
Let’s try to put it all into perspective. Even though we’re on a bumpy ride for, say, the next 12 to 18 months, America has seen far worse in its 246-year history. We’ve had depressions, recessions, wars, pandemics and more. Even if things get tough, that too will pass and the US economy will once again retain its place on the world stage. After all, the United States has the most resilient and diverse economy of any country on the planet. At this point, you can make some changes to your portfolio, but you need to stick to your long-term plan and stay the course.