The S&P 500 has entered correction territory, losing 10% from its highs. There are three key issues causing the market volatility right now: Russia, inflation and interest rates.
Russia Invades Ukraine
We were saddened to wake up to the news of the Russian invasion of Ukraine. Loss of life, especially this needlessly, is hard to swallow in today’s modern world. Fortunately for us, we don’t have to fear an invasion, but we are watching our portfolios drop in value. Stocks may decline more during this period of uncertainty, but historical data shows that we should stay invested. Going back to Pearl Harbor to today, the stock market after war has begun was up 50% of the time after one month. After a year of war breaking out, the market has been up 75% of the time. Today, many investors wonder if they should reduce their exposure to stocks because of the fear of a war between Russia and Ukraine. History would suggest that exiting the stock market now would be the wrong decision. It usually is not a good idea to sell into a panic.
Over the last year US inflation has topped 7%, but much of this is due to COVID related supply chain issues, but now the Russia invasion is making things worse by running up oil and natural gas prices. If you remove Oil and Natural gas prices from the consumer price index, inflation is starting to soften. The best inflation hedge is US large cap stocks. This is because companies have the ability to raise their prices and adjust their products in order to maintain profitability. We are seeing this in company earnings reports. Thus far 84% of the S&P 500 companies have reported earning for Q4 2021. 77% of those reporting had earnings exceeding analyst’s expectations. Additionally, the quarter’s earnings growth rate is 30% above the period a year ago. The fundamentals of the US economy remain strong.
Interest Rate Increase
In order to slow down inflation, the Federal Reserve will be increasing interest rates in 2022. This alone was causing stock market volatility as investors monitor the effects of rising interest rates on companies cost to borrow. Higher rates, while still historically low, are hurting bond values. We have adjusted our bond portfolio’s by adding short term inflation protected bonds and shorting our bond maturity time to three years. As rates increase, we will be able to cycle through our bonds faster to get the new higher rates. We still need bonds in the portfolio to help buffer stock market volatility and surprise global events.
Market Volatility: Learn from History
It is indeed 2022 and not the 1980’s, but we can learn a lot from history. Keeping the portfolios invested while accepting wild market swings has the greatest probability of success vs going to cash to try to time the markets rebound. We build financial models knowing that markets can drop 20% and never rebound and that our clients can still make it through retirement. For retirees, we hold up to two years of portfolio withdrawal needs to make sure we are never selling in a down market. The bottom line is, seeing accounts dropping in value is never a good feeling, but we know that we will not be successful trading in an irrational market and that long term we will win.