By Allen Giese, ChFC®, ChSNC®, CLU®
The first six months of 2022 saw the S&P 500 decline 23.6% from its all-time high at 4,796.56 on January 3 to a closing low of 3,666.77 on June 16. The index finished its worst first half since 1970 at 3,785.38 on June 30.
More noteworthy even than the extent of the decline was its gathering violence: in mid-June, the market ran off a streak of five out of seven trading days on which 90% of S&P 500 component stocks closed lower. This is one-sided negativity on a historic scale.
Let’s stop right there. Because regardless of any and all other points I wish to make in this report to you, the most urgent should already be clear. Simply stated, the best way to completely destroy any chance for lifetime investment success has historically been to sell one’s quality portfolio into a bear market.
But to sell when investor sentiment is sufficiently negative to drive 90% of S&P stocks lower on five out of seven trading days—to sell, that is, when everyone else is selling—must strike us as the height of long-term folly.
With that clearly on record, let me attempt to make some kind of sense out of what’s going on here. To do so, I need to take you back to the bottom of the Great Panic on March 9, 2009. From that panic-driven trough, the S&P 500 (with dividends reinvested) compounded at 17.6% annually for the next 12 years, through the end of 2021. At its peak this past January 3, the index was up seven times from its low. This was one of the greatest runs in the whole history of U.S. equities.
Moreover, the index’s compound return over the last three of those years—2019 through 2021, encompassing the worst of the Covid-19 plague—shot up to 24% annually.
But when inflation soared late last year, it became evident that equities’ jaw-dropping advance over those three years had been fueled to some important extent by an excess of fiscal and monetary stimulus, mounted to offset the economic devastation of the pandemic. In one sentence: The Federal Reserve created far too much money and then left it sloshing around there far too long.
And since inflation, as Milton Friedman (Nobel Prize-winning economist, Univ of Chicago) taught us, is always and everywhere a monetary phenomenon, we investors now find ourselves having to give back some of the extraordinary 2009-2021 market gains, as the Fed moves belatedly to sop up that excess liquidity by raising interest rates and shrinking its balance sheet.
Yes, the war in Eastern Europe and supply chain woes of various kinds have exacerbated inflation, but in my judgment, they’re irritants: Monetary policy (seasoned as well with a bit too much fiscal stimulus) got us into this mess, and monetary policy must now get us out. The fear, of course, is that the Fed will overtighten, putting the economy into recession.
As your financial advisors, our position in all our discussions with you has been, and continues to be: So be it. If an economic slowdown over a few calendar quarters is what it takes to tame inflation, it would be by far the lesser of two evils. Long term, high inflation is a disease that devastates not just investment portfolios but the global economy. It must be destroyed.
With regard to our investment policy, nothing has changed, because nothing ever changes. That is: We are long-term, goal-focused, plan-driven investors. We own diversified portfolios of asset classes with strong historical evidence of giving you the ability to capture the global capital market rate of return. We act continuously on our financial and investment plan: We do not react to current events, no matter how distressing they may be.
After 30 months of chaos—the pandemic in its several variants, the election that would not end, roaring inflation (most painfully in stupefying gas price increases), the supply chain mess, war in Europe, and so on—we’re all understandably exhausted. (And I most certainly do mean we.) That’s when the impulse to capitulate—to get to the illusory “safety” of cash—becomes strongest. So that’s when the impulse must be resisted most strongly. And that’s our job.
This too shall pass. We’re here to talk all this through with you at any time. And as always, to our clients: Thank you—it is a privilege to serve you.