The beginning of a new quarter unfortunately did not bring with it a change in market direction. Investors have continued to wrestle with many of the same risks that plagued markets during the prior quarter: Federal Reserve tightening, COVID lockdowns in China, the war in Ukraine, and the continued unwind of what some have called a pandemic-era bubble (see Teladoc this week – down 40% after releasing earnings and now down 90% from February 2021 highs).
As we close April, global stocks, as represented by the MSCI All Country World Index, are now down close to 13% for the year. Bonds, normally what investors think of as their “safe” money, isn’t all that far behind with the benchmark U.S. aggregate bond index down more than 9%. In industry parlance there just haven’t been many places for investors to “hide.”
We’ve already mentioned the issues or risks that have driven the negative results and sentiment. While the bursting of the pandemic-era bubble in stocks like Teladoc, Netflix, Peloton, and many others has perhaps flown under the radar for the average investor the other issues have been widely reported and aren’t new. Rather than rehash those issues again we thought it may be more useful to take a step back and remind investors that there is one very real positive that comes with negative returns and lower prices – improved valuations. As value-oriented investors that makes us much more constructive on future returns. We’re not going to argue yet that either bonds or stocks are cheap, but it is fair to say (and in the case of stocks we’ll show you) that valuations are back to more reasonable levels – something we haven’t been able to say in a number of years.
Let’s look at some of the positives for each of the three areas that make up our typical portfolio – bonds, stocks, and alternatives.
Bonds – there are two clear positives in our mind as we think about future performance. The negative results in fixed income year-to-date have been the result of a dramatic shift in what investors expected out of the Fed this year. At the outset of 2022 the market implied expectations for Fed rate hikes in 2022 sat at just two increases of 25 basis points each. In only a few short months that mindset has shifted to expecting a significantly much more aggressive Fed with three successive rate hikes of 50 basis points each expected at the next three Fed meetings. The Fed is also set to start selling bonds off their balance sheet far earlier than previously anticipated. The positive in all of this is that the market has already priced in a lot of very aggressive, future activity by the Fed. With that much activity priced into markets there is a real possibility that the worst may be over in bonds, at least in the near-term.
The second positive in fixed income is that with higher current yields bonds are able to offer something they couldn’t when rates were lower – a cushion or downside protection in a recessionary scenario. When rates were lower there was very limited ability for them to go even lower and produce any type of meaningful positive return. At current yield levels, however, there is again room for rates to fall and produce decent gains.
Stocks – the most obvious positive to point to is that valuations are at much more reasonable levels compared to the last few years. As the accompanying graphic shows, the forward-looking P/E ratio for the S&P 500 is back to its 7-year average for the first time since pre-pandemic.
As comforting as this is to see we hesitate to get too excited, too quickly. Higher inflation and higher interest rates typically result in lowering P/E ratios. Valuations are improved, but we’d stop short of calling them “cheap”. We’d love to strike a more positive tone and argue that markets are poised for a quick rebound, but history tells us that markets swing between excesses (cheap/expensive) and this chart, while encouraging, shows them closer to a “fair” price than either extreme.
Alternatives – the story here is much simpler. For accounts comfortable utilizing our preferred alternative strategies we just hope for more of the same. This has been the lone bright spot for portfolios with returns positive on a combined basis across our five strategies. Three of the five have had double-figure positive returns while the other two were down only a few percent.
One last item that I’d like to touch on that also fits within our theme of big picture positives that come out of periods like this is tax loss harvesting. We know many advisors only look at tax loss harvesting opportunities in November or December (if at all) and it’s typically a reactive exercise to just offset gains elsewhere in the portfolio. We view tax loss harvesting very differently and have intentionally structured our portfolios to create the flexibility to take capture opportunities whenever and wherever they may occur. Being closely associated with an accounting firm we recognize the very real, meaningful tax savings that those losses can create in the future. We won’t speak to why others may not take advantage of this same opportunity to add value (or do so only in November or December), but we will say it seems like an enormous, wasted opportunity.
We understand and appreciate that the start of 2022 has been difficult and disappointing. Market selloffs may be a natural part of investing, but that doesn’t make periods like the last few months any easier. Our team is here and available to talk through any questions or concerns you may have.
Unless stated otherwise, any estimates or projections (including performance and risk) given in this presentation are intended to be forward-looking statements. Such estimates are subject to actual known and unknown risks, uncertainties, and other factors that could cause actual results to differ materially from those projected. The securities described within this presentation do not represent all of the securities purchased, sold or recommended for client accounts. The reader should not assume that an investment in such securities was or will be profitable. Past performance does not indicate future results.