Since the start of 2022, stocks have dropped about 20% to 30% and bonds have declined about 11%. For investors with balanced portfolios, you’d have to travel back in time for many decades to find a comparably dismal start.
Inflation is the primary cause, of course. In response, the Fed is aggressively trying to put the genie back in the bottle. Since March, they have raised short-term interest rates three times to 1.5%. And, there’s more to come. Expectations are they’ll hit 3.5% by the end of the year.
Focusing first on bonds, all of this begs a reasonable question, “With the Fed less than halfway done, shouldn’t we just get out of bonds completely?”
As I wrote last week, with the Fed’s future rate hikes already factored into today’s prices, I feel we’ve seen the worst of the bond market decline. In baseball terms, for bonds, I’d say we’re in at least the middle of the 8th inning.
Given this view, I’ve recently shifted more heavily into corporate bonds and have also modestly extended the average maturity of my clients’ bond portfolios. With interest rates now higher, I feel bonds offer both ballast and income. This combination of benefits has not existed in bonds for many years. In short, it feels like the wrong time to bail on the bond market.
Turning now to stocks, it’s been an equally tough period. Everyone is on recession watch. Officially, we don’t find out about recessions until one is either well underway, or already over. However, the stock market typically ferrets out a recession many months before one hits and sometimes it’s wrong. With stocks down this much, I think we’re getting a pretty good signal that a recession is probably on the near-term horizon.
This, too, begs another reasonable question, “With things looking so ugly out there, how much worse do you expect the stock market to get?”
With my view that inflation will soon peak and, in turn, the Fed will be done raising rates by year’s end, my base case is that we should expect a more typical bear market decline of 30% to 35% in stocks. Again, in baseball terms, for stocks, I think we’re sitting in the bottom of the 6th inning. This is not close enough to the end to exhale. But, it’s certainly not far enough away to bail out of stocks or even cling to cash.
Bear markets are tough to stomach, for sure. And, with bonds also in decline, this one feels like a one-two punch. But, it’s imperative to find resolve and prepare for the recovery phase of a bear market. It’s likely not as far away as it seems.
Jason P. Tank, CFA, CFP® is both the owner of Front Street Wealth Management, a purely fee-only advisory firm and the founder of the Money Series, a non-profit program committed to providing open-access to financial education, for all. Contact him at (231) 947-3775, by email at [email protected] and at www.FrontStreet.com