As I write this column, the markets can’t seem to make up their mind about whether the greatest threat is inflation or recession. Commodity prices of everything from oil to copper and lumber have fallen sharply on fears of an economic slowdown in the United States. The 10-year Treasury note, on which mortgage rates are based, has fallen from 3.50% to 2.75%.
But by the time you read this in a few days, the markets may have turned around again — and you may have been whipsawed if you decided to speculate on whether the bottom in any market had been reached.
The first half of 2022 was the worst since 1970, with the S&P 500 stock index down 20%. At the same time, rising interest rates caused the S&P Bond index to decline almost 14%. There was no place to hide from the carnage, as even money kept safely in CDs or money market funds lost purchasing power to inflation, raging at over 8%.
Now those losses are very visible as retirement accounts and brokerage firms send out their latest quarterly performance statements. Don’t look around for a fund manager or segment that beat the market.
Energy was the best performing sector in the first half of the year, rising 32%. But in the first few days of July, oil fell from over $120/barrel to under $100/barrel, making energy stocks among the hardest hit.
Trying to pick winners and losers among individual stocks is bound to get amateur investors in deep trouble. Even the pros haven’t done well this year.
Beware of changing strategies midstream
A 60/40 balanced portfolio of stocks and high quality bonds has always been considered the optimum asset allocation for a conservative investor. But it didn’t work in the first half of this year, with both stocks and bonds losing money.
So should you switch your allocation now, for the second half of the year? That could be a fatal mistake, according to Dan Wiener and Jeffrey DeMaso of the Vanguard Independent Adviser newsletter (AdviserOnline.com). They have given me permission to quote their comments on the Vanguard Balanced Index Fund with a classic 60/40 allocation.
“Vanguard’s most plain-vanilla 60/40 option is down 17.1% this year — the worst six-month showing for the fund since March 2009. Back in 2008–2009, stocks dragged the fund down while bonds were up 7%. This time stocks and bonds have fallen in sync—and in the case of bonds, fallen at a record-breaking pace.
“This has led some to conclude that blending stocks and bonds is a dead end. Neither Jeff nor I are jumping to that conclusion. The classic 60/40 portfolio may need a rethink. But if you’ve been invested in a diversified portfolio, this could be precisely the wrong time to steer a new path.
“Jeff calculated all six-month returns for a 60/40 portfolio back to 1945 using available index data. (This was well before Vanguard’s founding, of course.) He identified every period with a 10% or greater decline — there were 15 of them, not including the first half of this year.
“On average, the balanced portfolio gained 10% over the next six months and was negative only once.
“Over (the succeeding) 12 months, the 60/40 portfolio was higher every single time — with an average return of 18.4%.
“Given that a lot of pain has already been handed out in both the stock and bond markets this year, you may be encouraged by the fact that returns have been particularly attractive following periods like the one we are currently going through.”
Consider yourself warned. Human nature tends to remember only the most recent events. And in the past three years, the average annual return of the S&P 500 has been a record-breaking 17%, compared to the 10.1% average annual return over the past nearly 100 years.
During that century-long period, several bear markets shaved 50% off the index each time — notably in 1983-74, 2000-2001 and 2008-2009. Still, with the Dow at 30,000, we are higher than each previous bull market peak.
Over the long run, it has always paid to be bullish on America.
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