After two pandemic years of perhaps unexpectedly good returns in stock and bonds markets, the first four+ months of 2022 have been terrible—the worst start since 1970 (Note 1).
Stocks and bonds moved down together as inflation, high interest rates, the war in Europe, high energy prices, and continued supply chain disruption caused great uncertainty for the near future. The US Gross Domestic Product went down 1.4% in the first quarter. It was a perfect storm of bad news.
A hypothetical portfolio of 60% stocks 40% bonds went down 11.5% from January 1 to the end of April (Note 2), and continued to slide in May.
Tech stocks, which were the pandemic darling, went down about 50% more than the overall market. International stocks were down about the same as US. Note 3
Bonds were hurt by a big increase in inflation and hawkish statements by the US Federal Reserve to raise interest rates. Mortgage rates went up substantially, with home prices at very high levels.
But even including the poor returns so far in 2022, that hypothetical 60/40 portfolio delivered a 6% return over the past 3 years… solid, if not outstanding performance.
Any Good News?
The headline inflation numbers received a lot of attention, but there’s more to that story. The primary drivers of inflation were: energy, food, and automobiles. The first two are related to the war in Europe because of boycotts on Russian energy and expected reductions in agricultural products from Ukraine and Russia, including fertilizer. (Ukraine grows about 10% of the world’s wheat.) Automobile prices went up because of continuing pandemic supply chain disruptions, mostly in Asia. All three of those components will level off eventually. In the meantime, we will see high inflation.
The NY Times has an interesting calculator that shows your personal rate of inflation; it’s less than the headline number if you didn’t buy a car, for example.
Higher interest rates have turned into higher yields (interest payments) from bonds—something that bond investors have wanted for more than a decade.
The decline in US GDP in Q1 (Note 4) was mostly driven by a decline in federal spending of 5.9% compared to the year-ago pandemic stimulus. Consumer spending on goods and services was up, so consumers were confident and had cash to spend. Consumers are now spending a lot more on services, which will help to restore some balance in the economy.
So that’s in the past. What about the rest of 2022 and beyond? Will some of the uncertainty resolve?
The Future
Free-market economies have the ability to self-correct. When the prices of goods and services go up, consumers and businesses shift spending to alternatives or reduce buying. New competitors or technologies can drive costs down.
There has been a lot of disruption in the past two years, but many businesses have become more efficient at delivering goods and services, adjusting to lower labor levels, which will lead to better profitability.
We have to assume that the war in Ukraine will continue for months or possibly even years, since the two countries have actually been at war since 2014 when Russia invaded and seized the Donbas and Crimea regions. For the people of Ukraine, it seems that good news is not imminent. But beyond that immediate region, countries will adjust. The US seems better positioned because of domestic sources of energy and agriculture.
Likewise, supply chain disruptions may persist for some time because China appears to be determined to maintain a Zero-COVID strategy by shutting down cities and regions to control spread. But even an authoritarian government-run economy has to eventually respond to its population, which appears increasingly restive over harsh restrictions. Disruptions will ease.
In a recent post, Fidelity Investments identified several reasons for optimism.
Notes:
- According to this MarketWatch article
- Using Vanguard mutual fund VSMGX as a proxy for a 60% Stocks / 40% Bonds portfolio
- Using Vanguard mutual fund VITAX (technology stocks) -19.7% vs VOO (S&P500 stocks) -12.9% vs VXUS (international ex-US stocks) -12% as of end of April 2022
- Bureau of Economic Analysis announcement
This information is of a general educational nature and not investment advice. Past performance is no guarantee of future returns. Investing involves the risk of loss. A diversified portfolio does not guarantee a gain or protect against a loss. Information in this post is believed to be accurate but may contain inadvertent errors.