Many portfolios have been trending downward over the last year, leaving investors nervous about their prospects in the stock market over the next few quarters. Interestingly enough, it may not be your stocks that are the biggest reason that you might be disappointed in your portfolio’s performance this year.
Historically there’s been a negative (inverse) correlation between the Stock and bond markets, at least over the last few decades. At times the stocks struggle and investors may flee to bonds in an attempt to give them a greater sense of stability. Aside from the inherent stability bonds typically provide, compared to stocks, when stocks see a bear market, the bond markets may also get a bump from the inflows of cash leaving stocks, causing a small price spike. Stocks go down, and bonds go up. Bonds go down, and stocks go up.
At least, that’s how it used to work up until recently. Over the last decade-and-a-half, we’ve witnessed some fiscal and economic Tomfoolery which has had some interesting consequences. One of the biggest is the decoupling of the stock and bond markets. In an attempt to prop up a stagnant Obama economy from the 2008-2009 financial crisis, The Fed had decided to keep rates artificially low for the better part of a decade. Now combine that with historically reckless government spending and printing of money, and we now have the world’s most predictable inflation crisis. If you liked the late1970s, you’d love the mid-2020s!!
So what is The Fed to do? They certainly can’t cut spending or stop printing money; that might have negative political consequences for our ruling class!! (perhaps a hint of sarcasm there) The Fed now must raise interest rates to try and slow the economy enough to bring inflation back to “normal” levels. Rising interest rates will negatively affect current bond holding. Your future bond holdings, however, will benefit as new issues pay higher interest rates to their investors. Until your portfolio cycles out the older, lower-yielding bonds, the fixed-income part of your portfolio will suffer in the interim.
Here are some metrics: As of 11/03/2022, the US Aggregate Bond Index is down 15.62% YTD. Now that number in and of itself might not mean a lot, but couple it with an S&P 500 index (stocks) that is down 22.1% YTD, and it’s a perfect storm for your portfolio to get crushed, regardless of whether you’re in an aggressive or conservative allocation. Let’s look at how this affects your portfolio specifically: If you had a typical 60/40 allocation (60% stocks & 40% Bonds, let’s say $100,000 portfolio) and your stock portion dropped 20%, but your bonds were up 10% ((60 x (-0.20)) + (40 x 0.1)) = -8% So you would be down to $92,000 from your $100,000 investment. This is what most investors are accustomed to, but what we’ve seen this year is more like this: your stock portion dropped 22% while your bonds were down 15.6% ((60 x (-0.22) + (40 x (-0.156)) = -19.44% or leaving you with $80,560.
Indeed, that’s nothing new; however, we’ve been down this road before, right? Well, sort of. The Bond and stocks markets certainly had some rocky periods during the late 1970 and early ’80s, but we had never had three consecutive quarters where both the bond and stock markets were down at the same time… until now. Let’s Go, Brandon!
So, what can investors do to protect themselves? The are several general tips that can apply to almost all investors;
- Don’t panic: Nothing is a loss until it’s realized. It’s only a paper loss until you sell.
- Have a defined long-term strategy and stick to it! Know your goals and how to get there.
- Know your true risk tolerance: Know how much risk you’re comfortable with and ensure your portfolio matches that.
- Rebalance: use the volatility in the market to your advantage!
- Utilize Asset Segmentation: segregate assets for specific targets/timelines.
The best thing you can do is give us a call here at The Financial Guys for a review of your current portfolio or for a hand putting together a roadmap for your financial future.