Market Update Note
After a hiatus in May from the equity market sell off, following a very weak April where the S&P traded lower by 8.72%, June has brought us a resumption of the bearish trend. Through yesterday’s close, the benchmark index was lower by approximately 9.3%. Given the extent of this rapid sell off across both equity and credit markets we wanted to share our perspective.
During the first quarter we saw credit markets post significant declines. As a broad measure of bond market performance, we use the Bloomberg US Aggregate Index. This index is an industry standard benchmark of investment grade credit. During the first quarter it fell an astonishing 5.93%, the worst quarter the index has experienced since 1980. To make matters worse, the index lost 1.54% in 2021, putting the index on pace to post two consecutive negative returning calendar years, not something fixed income investors almost ever experience.
On the other hand, equity markets, while negative posted very modest losses. The benchmark S&P 500 was off just 4.60% during the first quarter. Clearly not desirable, but also very small in the context of historical losses. This you recall came on the heels of what had been a golden age for the S&P 500, generating cumulative returns of over 100% in the prior 3 years. We had written previously that those outsized returns would need to moderate to a more normalized level. We have seemingly arrived at that period.
The Fed has been extremely clear and deliberate about the plans they have for getting inflation rates down toward their longer-term target of 2%. Some might argue, with the benefit of hindsight, that they have been too deliberate and should have acted sooner than March. By the end of the first quarter, we were somewhat puzzled by the disparity of performance between bond and equity markets. It appeared that equity markets did not believe what the Fed was articulating, while the bond market was running scared. That disparity in equity market performance has since caught up, and at the time of this publication, the S&P, is now off about 21% for the year. With this further downdraft in the market, we think the equity market has now largely priced in the future monetary policy tightening actions and has likely caught up to the bond market.
What remains an open question today is if the action by the Fed to tame inflation will go too far and precipitate a recession. We do not think that event is yet priced into markets. A recession in a capitalistic economy is a normal part of the cycle, and not something long term investors can proactively avoid. Based on historical performance the average recession would result in a market decline of 29%, so even if one were to manifest further market weakness should be less protracted. We would stress that the Global Financial Crisis of 2008 was far more than a typical recession, and in fact, was an existential threat to the global financial system. We do not envision a repeat of such an event.
Historically market performance following a recession is +40% 12 months forward and +54% 24 months forward.
Volatile markets can afford the opportunity for activities such as tax loss selling, where we can capture losses in securities to offset gains elsewhere. It’s also an opportunity to explore the inclusion of additional assets into an allocation which can add further diversification benefits. This period could also present an opportunity to accelerate cash deployment to take advantage of more attractive asset prices.
Should you have any questions on markets or your portfolio please reach out directly to your advisor to discuss.