I trust everyone is enjoying the beautiful summer weather, but the winds of change have been wild in the world of money with the financial markets having an extremely rough start for the first half of 2022. On the other hand, I want to start off on a positive note with the following chart going back to 1932 that observes that when the S&P 500 has fallen 15% in the first half of the year, it rallied in the second half with an average gain of 24%. However, we are certainly not at a point yet where we can say the markets are definitively at a bottom and I think the three critical keys for signs of a market bottom will be peak inflation/peak hawkishness by the Fed (the Fed raising interest rates is hawkish), China reducing Covid lockdowns opening up the second largest economy in the world and geopolitical improvement with the war ending in Ukraine. The markets also are at risk from a growing threat of China invading Taiwan.
Data compiled by Dow Jones Market Data shows that the S&P 500 has bounced back after past first-half falls of 15% or more with five instances going back to 1932.
For the second quarter of 2022, the S&P 500 fell more than 16% and largest one-quarter decline since March 2020 when the pandemic hit. For the first half of 2022, the broader equity market index dropped 20.6% for its largest first-half decline since 1970 and the S&P 500 also tumbled into bear market territory, down more than 21% from a record high set in early January 2022. The Dow Jones Industrial Average and Nasdaq Composite were not spared from the onslaught. The 30 stock Dow lost 11.3% in the second quarter, pulling it down more than 15% for 2022. The Nasdaq index suffered its biggest quarterly drop since 2008, losing 22.4%. Those losses pushed the tech-heavy composite deep into bear market territory, down nearly 32% from an all-time high set in November 2021 and down 29.5% year to date for June 30th 2022. Overseas, the markets also declined with the Pan-European Stoxx 600 falling 16.6% and MSCI World index down 18% for the first half of 2022. The bond market tanked with its worst start of a year in history, so there was no counter-balance from bonds to help offset the swan dives in the equity indices.
Going into the second half of 2022, the macroeconomic outlook remains uncertain as the war in Ukraine and inflationary pressures persist, prompting Central Banks around the world to continue on aggressive monetary policy by tightening and raising interest rates exacerbating fears of a global economic slowdown. Those steep first-half and quarterly losses came as investors grappled with sky-high inflation and tighter monetary policies with the objective by the Fed of a soft economic landing which amazingly appears to be possible with such a strong economy that may be able to endure the harsh consequences of the repercussions of the war in Ukraine and Fed’s efforts to squash inflation. I think the Fed raising interest rates with the intent to slow the economy and essentially putting people out of work is not the right medicine for the high inflation. The inflation we are enduing is from the horrific actions/policies coming out of Washington exacerbated by the war in Ukraine and lingering effects from the pandemic. Also, consider that we are in a mid-term election year which are notoriously weak and volatile times for equity markets which has played out to an extreme so far in 2022 as noted in the chart below indicating continued volatility into the end of the year.
In my research of past periods of high inflation and the markets performance, I observed that the S&P 500 suffered its worst first half in 2022 since the high inflation of 1970s in which inflation trended up from 5.5% culminating at 14% in 1980. An unemployment rate of 7% to 8% through the latter half of 1980 and into the fall of 1981 sharply climbed to 10.8% in 1982. The primary force behind inflation of that era is not a surprise. The biggest driver of inflation back then was the oil crisis – sound familiar? In comparison, today's global inflation is only recently above pre-pandemic levels, since mid-2021 (at 5% on average in 2021 through 2022 and 8.6% in May 2022) and we have low unemployment driving labor costs higher exacerbating the inflation challenges for the Fed. However, on a positive note according to analysis by S&P Dow Jones Indices and the Bloomberg chart below, historically there has been little to no correlation between the S&P 500 performance in the first and second half of the year. For example, the S&P 500 lost 21% in the first half of 1970, during a period of high inflation that the current environment has been compared with, but then the index went on to gain 27% during the last six months of 1970 as noted in the following chart:
Crossing the middle of 2022 may elicit a symbolic sigh of relief, but turning a calendar page does not alter market realities or address the matter of how best to position portfolios for the next six months and beyond which will be the critical task in an environment where the noise may only grow louder with certain signals appearing less favorable. Again, as we enter the second half of the year, most of the first half’s significant headwinds are still in place: high levels of inflation, slowing growth, rising interest rates, Fed policy uncertainty and fallout from Russia’s war on Ukraine. However, not all is bleak as we observe some potentially better news ahead, including potentially more moderate inflation, the ongoing resilience of the consumer, strong corporate balance sheets and a Fed that might lighten its tightening grip after completing its initial round of outsized interest rate hikes.
As long-term investors, we recognize that transitioning from pain to gain requires more than simply being patient, as if time could heal all investment wounds. Patience may be a virtue, but it is not its own reward. We have endured many market corrections of the past with the most recent being the onset of the Pandemic in 2020 when the S&P dropped in the first half of the year, but soared 21% in the latter half of 2020 and I think you can see where I am going with these charts. If I have any words of comfort, it is that universal losses at the pace of the first half of 2022 rarely continue in successive quarters. However, continued volatility will likely be with us as we are truly in unchartered waters in so many respects and the markets did decline for the three years of 2000, 2001 and 2002 for an over 40% drawdown, so I am not going to just paint a potential Rosie picture for the markets.
However, what we do know from history is simply to buy when prices are low for long-term rewards. However, as noted earlier, a severe market downturn for whatever reasons could lead to markets moving even lower so picking the exact bottom is not an exact science which is why many shrewd investors average their buying into the declines which is called dollar cost averaging. I worked with Sir John Templeton’s group in the Bahamas early in my career and Sir John taught me to “be greedy when other are fearful” and “be fearful when others are greedy”. Well, for sure many are justifyingly fearful at this time and the markets are down and can certainly go lower from here before the bottom, so what have we done, what can be expected and what should you consider doing?
- What we have done, from a money manager perspective, is sell all bond funds prior to the bond market carnage of 2022 and we moved that money into cash which we have been investing to build short maturity FDIC insured bank CDs and US Treasury note positions with the intent to roll the CDs and T Bills as they mature into new CDs and T Bills which we believe will afford higher yields in the future (some of that money may dollar cost average into stocks depending upon the clients risk temperament, financial goals, objectives and timelines).
- We have also paired-back equity exposure in client portfolios, but we do not have a crystal ball and do not know for sure when the markets will discount all the bad news present and to come with a potential black swan event like China invading Taiwan. Nobody knows for sure when the bottom will occur and when markets will turn higher and resume their long-term uptrends in anticipation of the better times ahead. What I do know from studying the markets and my over 4 decades of experience of investing is that wise investors did not panic and added to equities during past market corrections for the long term which has always resulted in new market highs. Yes, it is that simple if you have the stomach to endure the market corrections which is the price we all pay as investors for higher long-term returns on our money. For clients who are retired and drawing on their accounts, we have raised cash to cover their withdrawals for about a year so that we do not have to sell securities into declining markets.
- Earnings season will commence in earnest during the second full week of July 2022 and analysts at US financial group FactSet estimate an earnings growth rate of 4.1% for the S&P 500 companies, which would mark the lowest earnings growth rate reported by the index since the 4th quarter of 2020. We will be watching earning releases and forward guidance from companies very closely to determine at what rate we should dollar cost average and position back into stocks.
- If you have cash sitting in bank accounts hardly earning any interest and are inclined to invest that money for the long-term for potentially higher returns, bear markets such as what we are experiencing now have historically proven to be good opportunities to pick up bargains, so feel free to reach out to us for assistance adding to your accounts or opening new accounts to invest.
Physical gold and digital gold (Bitcoin?) are both fighting the headwinds of a strong US dollar which hit a fresh 20-year high with the dollar now almost a parity with the Euro and at $137.26 yen to the US dollar. On a personal note, if you have been thinking of traveling abroad and are not concerned about Covid, now is a great time with a strong US dollar. Of note, every significant correction in gold has been a buying opportunity in gold this century. Gold hit bottom in 1999 when the United Kingdom sold half its gold reserves. Since trading at the $252.50 level in August 1999, gold has made higher lows and higher highs. At $1733 on July 11th 2022, gold may be down on the year, but it is certainly not out as the yellow metal is closer to the highs than the lows of this century and it remains far above its technical support level from a long-term technical perspective.
I have been scratching my head about gold (literally). . . With the war, high inflation, risk assets tanking and growing geopolitical risks you would think gold would be at $3000 on its way to $5000 an ounce, but investors are growing impatient with gold which continues to decline and fails to break out on the upside moves with the headwinds of rising interest rates and a strong US dollar. However, gold has been a means of exchange since before biblical times and cryptocurrencies have been around for a little over one decade. The world’s governments are not fans of alternatives as they pose a threat to control of the global money supply, a critical factor for power and we cannot ignore the debasing of fiat “paper” money like the US dollar forever, so holding some gold as a form of insurance makes sense. The jury is still out on cryptocurrencies as they are going through their equivalent of the 1999 Dot-Com bubble bursting, so we will see what cryptocurrencies emerge as the future “Amazon” type opportunities for the new space as digital finance will be an integral part of our future.
Institutional Money Manager/Advisor update – Material Changes.
I spent the last eight years also managing global macro strategy multi-alternative mutual funds for major institutional fund companies and in that capacity learned a wealth of information that enabled me to better understand the workings of many sectors of the markets, many different types of securities and I am employing that knowledge and experience to better serve our valued clients. I have moved on and resigned from serving as co-portfolio manager on the AXS All Terrain Opportunity Fund. However, I am still serving as Investment Advisor on many 401K/Profit Sharing Plans for Paychex which is the largest 401K/Profit Sharing plan provider in the USA and, in that capacity, I am vetting many Institutional Investment Fund Companies with trillions of dollars under management and also advising companies and plan participants on their fund choices and investment allocations. Again, this experience gives me great insights into the markets which carries over into serving our valued clients at Castle Financial.
As always, we will remain “tactical” in our approach to managing money focusing on sector allocations and great security selections as markets and new technologies continue to evolve. We continue to send our valued clients timely updates, videos and newsletters via email, so please call our office if we do not have your current email address and also advise us of family, friends and co-workers who you feel will benefit by also receiving our timely and informative email updates.
We are truly living in challenging and unprecedented times to say the least and, as such, we should expect continued market volatility. It is important to remember that volatility is historically normal, and volatile markets do not necessarily mean negative returns. Yes, risks remain to the markets and the economy, as they always do, but it is important to remember that a well-executed and diversified, long-term-focused financial plan can overcome bouts of even intense volatility as we have all witnessed in the past.
At Castle Financial, we understand the risks facing both the markets and the economy, and we are committed to helping you effectively navigate this challenging investment environment. Successful investing is a marathon, not a sprint, and even temporary bouts of volatility like we experienced during the height of the pandemic and the war in Ukraine are unlikely to dramatically alter a diversified approach set up to meet your long-term investment goals. Therefore, it is critical for you to stay somewhat invested, remain patient, and stick to the plan, as we have worked with you to establish a unique, personal allocation target based on your financial position, risk tolerance, and investment timeline.
Castle Financial has strategically partnered with some of the leading global money management firms in the world with tens of trillions of dollars under investment management and this quarter we have chosen to send you the enclosed timely report from one of our institutional strategic partners, BlackRock, Inc. for additional insights into the global macro picture. Your second quarter 2022 account summary and performance report is enclosed. Our current disclosure statement is set forth on the Firm Brochure Supplement of Form ADV and our Customer Relationship Summary (CRS) are available for your review upon request.
As always, thank you for your business and the trust and confidence you have placed in me as your financial advisor. Please visit us at www.castlefinancial.com for a wealth of information and a plethora of great content on a myriad of financial topics and connect with us on social media. Please do not hesitate to contact us with any questions, comments, or to schedule a portfolio review if you have not already done so in the last 6 months. Rest assured that we are working harder and longer hours during these volatile and uncertain times, but realize that the long-term rewards of prudent investing are, we believe, still with us.
Al Procaccino II, MBA, CFF®, CFP™, CFS®, CDAA™
President & CEO