If you’ve ever planted and cared for trees, particularly fruit trees, you know that, in the initial years, the saplings require quite a bit of extra attention. Newly planted trees need lots of water until established, along with fertilizer and prudent trimming. Initially, trimming branches may weaken the tree, but it's important for the tree's long-term health. I view market corrections in the same light. Without periodic setbacks such as a correction or bear market, we would always be teetering on the edge of a bubble. Most of you who were investing in the early 2000s and during the 2008 financial crisis know when a bubble bursts, it is far more painful than an average correction.
This periodic trimming of gains (branches) is painful but necessary to keep us from reaching a point of absurd market prices that ultimately come crashing down. The current correction is certainly a trimming of gains which, in my opinion, are justified based on current economic conditions. Additionally, if we look at the last five years of returns, we were due for a pullback.
S&P 500 Calendar Year Returns
I wish I could write these without cheesy analogies and dad jokes, but I’m a dad who loves analogies, so that's what you will be getting.
So where are we now, and where are we heading?
If you remember from my last market update, I noted that the first quarter was rough, and the second quarter was even worse. The third quarter was (by those standards) relatively mild but still not positive. The charts below show the performance in Q1, Q2, and Q3 of different types of stocks, such as Large Value or Small Growth.
The S&P 500 finished the quarter down 23.87% year to date, and pretty much every asset class (stocks, bonds, real estate, etc.) is also down significantly. The most surprising aspect of this correction for conservative investors is the downturn in bonds. Bonds, which are typically an anchor of stability when stocks come crashing down, are down 14.61% (based on the Bloomberg US Aggregate Bond Index). Rising interest rates cause this downturn. Bonds and interest rates are inversely correlated, meaning when interest rates rise, bonds go down in value.
The Fed has been very aggressive in recent quarters in raising interest rates in order to curb inflation. This, in turn, has caused bonds to sell. Simultaneously, stocks have cratered (based on the fear of a slowing economy, rampant inflation, and tightening monetary policy).
No one can know exactly when or where a market bottom is, but we believe that we have seen the bottom or are very close to it. Valuations on stocks are fair, bonds now have attractive yields, and employment numbers are still strong. The Fed is still combating inflation by raising interest rates without causing a deep recession which is a very, very difficult needle to thread. Still, it is possible as long as employment remains strong.
If we have, in fact, found a market bottom, we do not expect a straight line out of this. As we have seen in October, the market will continue to move in wild swings until the Fed pauses its interest rate hiking campaign and we can build on a steady market recovery.
In all honesty, much of this information is speculative and not nearly as optimistic as some may think. It's speculative as I know enough about markets (with six advanced financial designations/degrees) to know that market movements in the short term are utterly unpredictable. I also know that many of you appreciate that honest assessment rather than disingenuous positive predictions are rhetoric.
Here is the good news: Even though we cannot predict the market's short-term movements, this isn't needed. We are not investing this quarter, next year, or the next five years. We are investing for our lifetime, and by keeping that timeframe in context, the market movements of today are merely noise. I know we prefer to have positive noise, but by tuning out the negative and focusing on the long term, we can build wealth or (at least) maintain our wealth!
This commentary on this website reflects the personal opinions, viewpoints and analyses of the Financial Strategies Group, Inc employees providing such comments, and should not be regarded as a description of advisory services provided by Financial Strategies Group, Inc or performance returns of any Financial Strategies Group, Inc Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Financial Strategies Group, Inc manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.
Written by: Brice Carter