Returns for the major stock indices and the current bond, brokered CDs, and money market yields are as follows:
|Dow Jones Industrial Average||-20.95%|
|Fixed Income Yields||1 year||2 year||5 year||10 year||30 year|
|Fidelity Government Cash Reserves Money Market Fund||2.54%|
The equity markets have been brutal through the first three quarters of 2022. Despite three intra-year market rallies of 10%, 8%, and 16%, the market has retreated to a new low each time. The S&P 500 is back to November 2020 levels. Every major equity index (including foreign), sector (excluding energy), and equity style is down significantly, with the tech-heavy Nasdaq (-32%) leading the decline. The US equity market’s performance so far in 2022 is the fourth worst start to a year since 1928, and the bond market is having its worst year (-15%) of all time. Even the textbook 60/40 portfolio, comprised of the S&P 500 and 10-Year Treasury, is down 20% year to date.
The US continues to deal with the worst inflation in 40 years. The Federal Reserve has a dual mandate by Congress to maximize employment and price stability (inflation). The Fed regularly states they want inflation to hover around or just over 2%. Clearly, they have been missing their mark, as inflation has remained above 8% in each of the last six months, even as energy prices have been subsidized by a 28% drawdown from the US Strategic Petroleum Reserve. In hindsight, the 40% increase in the money supply from February 2020 to March 2022 proved excessive in dealing with the pandemic. Despite noble intentions and undoubtedly challenging unforeseen circumstances, their experiment has not gone well and is now being unwound. The Fed is finally trying to control the bleeding and bring inflation down. Their balance sheet is shrinking (slowly), and the interest rate increases are beginning to slow the amount of money circulating in the economy.
While we lay much of the inflation problem at the feet of the Fed, they are not alone globally, as Central Banks around the world have been printing money (monetizing debt) by buying bonds and artificially trying to keep interest rates down. Interest rates are ultimately the price to “rent money,” and when supply is up, then the cost of money comes down. The inverse is what we have now: the supply of money is being reined in, and rates are climbing. Global banks are now unwinding their balance sheets, effectively reducing supply and driving up the cost of money (higher interest rates). Moreover, the Fed expects to raise Fed fund rates (the price at which banks can borrow from one another) in November, December, and February to bring the rate up to 4.75%.
As these interest rates rise, bonds, brokered CDs, and money markets have become more attractive. We have begun adding more fixed income to some portfolios. We believe rates will continue to rise, so our concern now is patience. Ideally, we desire to build laddered portfolios, meaning we want to diversify the maturities and interest rates within our fixed income. Though these securities are becoming more suitable for some, we continue to believe that equities are ultimately the best hedge against inflation and the best way to grow your wealth over long periods of time.
At LYNCH & Associates, we again understand that long-term investing principles are being challenged. Bear markets are never fun, often painful, and the story (news cycle) that rides on their back is often compelling, and this time is no different. As we wrote last quarter, when the tough news turns, it becomes good news. Interest rates normalizing and supply chains healing are positives, and when the inflation numbers turn down and/or the Russia war subsides, the markets could rebound quickly, and again long-term investors will be rewarded. We remind ourselves that recessions and bear markets often mark favorable entry points and do not last long relative to economic expansions and bull markets, as illustrated in the graph below.
We thank you for your continued confidence in LYNCH & Associates. As always, we welcome you to schedule an appointment to review your financial situation.
Ryan T. Lynch, CFP® ChFC®
Form ADV Parts II & III of the LYNCH & Associates Uniform Application for Investment Advisor Registration and the LYNCH & Associates Code of Ethics is available to all clients at any time. If you would like to receive a copy, please contact Jennifer Farless at (812) 853-0878 or [email protected].
Office: 10644 Newburgh Road, Newburgh, IN 47630