November 7, 2022: Year-end Outlook

Before looking ahead, we think it instructive to review 2022 in all its horribleness.  We know it has been a difficult year for investors and here is some data to put things in perspective, all of which was taken from Morningstar, Inc.

The U.S. aggregate bond index had a total return of -14.6% for the first 3 quarters of 2022.  The 2^nd worst start to a year was a -3.9% total return for the first 3 quarters of 1981. Bond returns have not just been bad, but bad at an unprecedented level.

And then we turn to stocks.  The total return for the S&P 500 Index for the first 3 quarters was down 23.9%, the fourth worst start to a year only eclipsed by 1931, 1974, and 2002.  Another notable statistic is that through September, 94% of asset classes have lost money (105 out of 112 Morningstar asset classes).  This ties the record with 2008 when 94% of asset classes lost money. 

What makes this period so difficult is that it is historically rare for U.S. stocks and bonds to both be negative at the same time.  Since 1929, there have only been 2 calendar years when both the bond and stock indexes lost money (1931 bonds lost 2.3% and stocks lost 43.3% and 1969 bonds lost 0.7% and stocks lost 8.5%).  A moderate portfolio of 60% stocks and 40% intermediate bonds was down a stunning 20.6% for the first 9 months of this year.  So, the numbers are bad – epic bad, but where do we go from here?  What is the outlook going forward?

When we analyze the 1-year returns following the 10 worst starts to a year we see that the average return for a 60/40 portfolio is 9.9%.  Above we noted that 94% of asset classes have lost money through the first 9 months of the year.  In 1994 80% of asset classes lost money, 2008 94% lost money, and in 2018 79% lost money (these were the most extreme years by far going back to 1990).  What is interesting is that when we look at the year following these years, we find something compelling.  In 1995 4% of asset classes lost money, in 2009 2% of asset classes lost money and in 2019 0% of asset classes lost money.  Historically, it has made sense to ride out the tough times as you have generally been rewarded for staying invested.  This is why timing the market is so difficult to do.

Finally, a word about inflation.  We do not know when inflation will peak and start to come down.  What we do know, is that since 1926, the average 12-month return for the stock market following peak inflation has been a positive 21.3% and bonds have averaged a positive 7% return.  Assuming we are near peak inflation, the following 12-month returns could be attractive.

One final note of optimism.  Historically, 4^th quarter stock returns during a mid-term election year tend to be quite strong, averaging 6.5% (compared to 3.3% during Presidential election years and 2.7% during non-election years).  This may have to do with relief from no longer being subjected to political ads.

We hope that providing you with this list of historical precedents provides you with some peace of mind.  Nobody likes to watch their portfolio lose value and we may have more volatility and losses before this bear market is over.  However, we believe that history may once again repeat itself and provide for a return to more normalized returns going forward.