When Can We Expect Our Portfolios to Recover? Plus, the Latest Banking Crisis.
By Jon Aldrich
It has now been about 15 months since stock and bond markets started their miserable run and we are still a long way from getting back to where we were at the beginning of 2022.
We have been so accustomed to sharp snapbacks from corrections in the last 15 years or so as the Government and the Federal Reserve have always swooped in to rescue markets with stimulus or cuts to interest rates. Remember how quickly we rebounded from the COVID crash 3 years ago? We also bounced back quickly from several other large market drops caused by things such as The Flash Crash of 2010, Brexit, the European Debt Crisis, etc. Things seemed to usually recover very quickly after these crisis that we forget that the last couple of big bear markets lasted 43 and 37 months respectively for a 60/40 portfolio (a balanced portfolio of 60% stocks and 40% bonds) to claw back to even. (We discuss 60/40, because most investors are not just all stocks or all bonds and have some kind of balanced mix).
However, those last couple bear markets (2000-02 & 2008-09) were primarily driven by roughly 50% total stock market declines, while bonds actually performed well in those periods. Bonds did well in those periods because interest rates dropped in both of those cases which were also accompanied by recessions.
The current bear market is a bit unusual as we have had a large drop in both stocks and bonds, but the economy is still chugging along reasonably well. However, if the economy does eventually land in a recession, stocks will likely fall again. However, this time bonds prices should rise as interest rates almost always fall during recessions and they should now do a much better job of offsetting losses in stocks than they did in 2022, because we now have much higher interest rates. This not only helps produce more income, but also can allow for more gains in bond prices as higher rates provide more room for interest rates to fall. (Bond prices rise as interest rates fall while bond prices fall as interest rates rise).
Did Something “Break” with the Silicon Valley Bank Failure?
Stubbornly high inflation is complicating things as the Federal Reserve will continue to raise rates until inflation is under control, and likely won’t stop until something ‘breaks’. Was the failure of Silicon Valley Bank, the 2nd largest bank failure ever, the first domino to fall in something ‘breaking’? That remains to be seen, as SVB was highly concentrated in Silicon Valley Startups and also experienced a ‘bank run’ with many customers trying to withdraw all their money at once because some of the Venture Capitalists were telling them to do so. However, most other banks that have much more diversified customer bases are doing fine. SVB also got into trouble by purchasing too many longer-term bonds when rates were very low, and then had to take huge losses when they sold these positions to produce the cash needed for customer’s cash withdrawals. Sure, they did buy ultra-safe U.S. Government Bonds, but they bought bonds with long maturities when rates were very low to try to get some extra “yield”, but by doing this, they were just asking to get burned if interest rates shot higher like they have done. This was a big FAILURE by Management.
In a world of near-zero interest rates, SVB put the money in long duration fixed-income assets in search of a higher return. Regulators after the 2008 crisis had deemed these Treasury bonds and mortgage-backed securities nearly risk-free for the purpose of measuring bank capital. If regulators say they’re risk-free, banks and depositors may be less careful.
But those securities declined in value as the Fed took interest rates up quickly to break the inflation it helped to cause. SVB had enormous capital losses if it were forced to liquidate those assets before maturity. That’s exactly what happened as SVB customers withdrew their deposits. The San Francisco Fed regulates SVB and somehow missed this rising vulnerability. The Fed and Treasury will try to blame the bankers, but they are as much if not more culpable. The idea of elevating San Francisco Fed president Mary Daly to the Board of Governors seems preposterous after SVB.
It appears again, that banks have another crisis on their hands. Does that sound familiar? Banks, Can’t Live With Them, Can’t Live Without Them!
2023 and the Outlook for the 60/40 Portfolio:
2023 started out reasonably well after the bloodbath that was 2022, but in the last couple of weeks has given back most of the gains it had compiled in January and February. Inflation is proving more stubborn to control than originally thought and the Federal Reserve has had to keep its foot on the gas pedal in continuing to raise interest rates to try to tame rising prices. As I have mentioned previously it certainly appears that it could take a few years for balanced portfolios to get back to where they were before 2022 commenced.
You have probably heard the calls that the 60/40 portfolio is dead, but now that bond yields have shot up to levels not seen in 15 years, the opposite is likely true. Since bonds have juicy interest rates again, they can provide much more ballast to a portfolio then when interest rates were nil. Remember, bond prices go up when interest rates go down, and when rates go up as they have been doing, bond prices go down, and this is what has happened the last 15 months. Also, when you can get yields over 5% on safe assets such as Treasury Bonds and Certificates of Deposit that certainly is going to help returns in a balanced portfolio going forward. I would venture to say that calls for the demise of the 60/40 portfolio have been greatly exaggerated.
Because of the large drops in stocks and bonds, the good news is that future expected market returns are now much better than they were as we entered 2022. The not so good news is that it may still take a couple more years to get back to where we were when 2022 began. Below is what Vanguard recently penned in their 2023 economic outlook:
Source: Vanguard: 2023 Economy & Markets
What it all boils down to is as investors we are going to have to be patient as the recovery in our portfolios is going to take some time. As one of the greatest investors of all time, Warren Buffett, once said, “The stock market is a device to transfer money from the impatient to the patient." We should all hope to be patient investors for the next couple of years, however with all the headlines you will see regarding the current banking crisis and other things ‘breaking’ in the economy, our patience will be tested.