May 20, 2022
Dear Clients and Friends,
This year continues to be challenging for investors. The S&P 500 Index posted one of its worst returns for the month of April in decades, and the trend has continued into May. Traditional safe havens like bonds have fared poorly, as rising interest rates have driven bond prices down. While bonds typically provide a ballast to one’s portfolio during periods of volatility, the decline in both stocks and bonds has made current volatility feel worse than usual. Markets don’t respond well to uncertainty, but it’s getting a healthy dose this year dealing with high inflation, tighter Federal Reserve monetary policy, COVID-19 shutdowns in China, and snarling global supply chains, all while the war in Ukraine continues.
Investing mistakes often take place during periods of elevated volatility. One of the most frequent is trying to time the market by jumping in and out. Market timers must be right twice and timing the return to the market can be extremely difficult to pull off. Markets can turn quickly and missing even just one big up day can significantly reduce returns over time. The biggest daily gains tend to come in down markets, making them especially difficult to predict. Time in the market, not timing the market, has proven beneficial for long term investors.
When markets are shaky, it can be helpful to look to long term fundamentals that have provided the foundation of positive returns for stocks and bonds over time. For stocks, gains depend on the ability of corporations to grow earnings, which they have continued to do during first quarter earnings season—S&P 500 Index earnings per share are on track to increase 10% year over year. As for bonds, corporations and consumers enjoy strong balance sheets and have the financial firepower to pay their debts. While the future is always uncertain, we believe those fundamentals remain in place.
Even against a potentially supportive fundamental backdrop, the volatility we’ve seen in stocks this year is not unusual. Although negative returns for a full calendar year are infrequent, corrections are fairly common. Since 1980, the S&P 500 Index has been negative for a full calendar year just seven times, but the average decline within any year has been 14%. Mid-term election years have tended to see increased early year volatility, as the honeymoon period for a new president ends and political uncertainty rises. Inflation can also be challenging. Years with inflation over 5% have seen more frequent stock market declines than a typical year, but stocks have still been higher more often than not.
Amid the global economic and geopolitical uncertainty, the core domestic economy is still quite stable. Weekly consumer spending data is above typical baseline levels. Job seekers are participating in a tight labor market with twice as many openings as unemployed people. Businesses are enjoying high profit margins despite cost pressures. The economy is expected to grow in the latter part of this year after a surprise contraction in the first quarter, though the growth path may be bumpy as monetary policy is recalibrated from exceedingly loose to moderately tight and consumers and businesses adjust to higher borrowing costs.
The various headwinds facing markets this year have driven investor sentiment to extreme levels of pessimism. For example, a recent survey from the American Association of Individual Investors (AAII) showed the lowest number of bullish investors in almost 30 years. Going back to 1988, when the percentage of bullish investors in this weekly survey has been less than 20%, forward returns for the S&P 500 Index have been impressive. Specifically, stocks have been positive more than 90% of the time over 3, 6 and 12 months by an average of 6.7%, 12.6% and 19.8% respectively.
We believe patient investors stand a better chance of meeting their long-term goals. No one has a crystal ball, but at lower valuations, history suggests the chances of above-average returns going forward may be rising. We encourage long-term investors to stick to their game plan and view these pullbacks as further investment opportunities.
As always, please feel free to reach out should you have questions regarding our outlook or your portfolio.
Gallacher Investment Committee