It Was Just a Matter of Time

Is This the Long-Awaited Market Correction?

By Jon Aldrich

The S & P 500 is off about 9% from its highs at the beginning of 2022. The Nasdaq 100, comprised of a lot of the high-flying tech stocks that have amassed huge gains the last few years, is off about 14% from the highs. Most bonds are down 2%-3% so far this year. Happy New Year!

It has been quite some time since I have felt the need to write a blog due to volatility in the markets, but it appears that time is now here. I have been telling clients in my review meetings for the last couple of years now (most are probably tired of hearing it) that the next few years could be rather challenging from an investment perspective. U.S. Stock market valuations are close to all-time highs and bond yields are still not too far from all-time lows.

In the good ole days, if stock valuations became excessive, one could just reduce stock exposure and buy Treasury bonds or Certificates of Deposit that were yielding 5%-6% and were essentially one of the safest assets on the planet. These days, 10-year Treasury Bonds yield about 1.75% (5 year CD’s are yielding about 0.28%, not much better than the mattress). With inflation running north of 6%, you can see that your purchasing power is taking a pretty good hit if you have a lot of money in these investments. Of course, you can purchase lower quality or “junk” bonds and get more yield, but you also run a greater risk of not getting your money back. There is no free lunch! (Although, I do have enough points at Chick-Fil-A for a couple free lunches)J

It seems like all the things we felt long ago would trouble the markets are starting to trouble the markets:

• High Inflation
• Federal Reserve beginning to raise interest rates
• Spike in market interest rates
• Russia on brink of invading Ukraine
• Possible slowing economy due to Omicron variant
• Stretched stock market valuations
• Stocks having 3 great years in a row and a bull market since 2009. (Stocks go both up and down, lest we forget)

I think I have shown this table before which lists all the S & P 500 market corrections >5% since the March 2009 Great Recession low. If you go back and read the reasons stocks fell (on the right side of the table) it probably brings back some memories over the last 12 years or so. You can see that there have been quite a few corrections in the market since 2009 with the median decline being -7.6%.  Therefore, the current correction we are experiencing is not too far from what the median correction has been the last 12 years. Also, the median length of the corrections from the high to the low has been 26 days, and we are only 17 days into the current sell off.

Source: Charlie Bilello, Compound Advisors

There are a lot of headwinds out there, with the largest one being the current bout with high inflation. The markets can tolerate moderately high inflation, say up to 5% or so for periods of time, but once it gets above 6% both stock and bond markets seem to struggle as they are now.

However, there are some bright spots in diversified portfolios. Commodities are knocking it out of the park lately and are up nicely. Emerging markets which have underperformed for several years are also positive so far in 2022, Gold is hanging in there and Large Foreign stocks, while still slightly negative for the year are doing a good job outperforming the U.S. markets. We have also kept bonds on the shorter maturity end of the spectrum the last year or so, and that has helped mitigate some of the losses longer term bonds have had. If we are in a new regime for stocks, than quite possibly, these asset classes just mentioned might finally start making nice contributions to the portfolio even if U.S. stocks aren’t doing so hot.

There is likely more downside to come in the next few weeks, but after several years of really good market gains without many “corrections” (Except for the COVID crash in 2020) the markets have been extremely calm the last few years. And, on average, we experience a double-digit decline in the stock markets about every 18 months. However, we may be entering a new era where there is going to be more volatility in the markets that we will have to get accustomed to.  This is normal and a feature of the markets that has always been there and likely always will be. But with inflation running at 6-7% you can’t really just sit in cash and allow inflation to silently erode your portfolio either, as having exposure to stocks and bonds will provide a fighting chance to keep up with inflation. Stay tuned, and as long as markets continue to express more volatility I will be penning more frequent articles to try to keep you informed.

Oh, and make sure you turn off CNBS and a lot of the other fear mongering channels. Your anxiety level will be much lower! They have been waiting for a while to bust out the big red headlines of how much the market is down, and are excited at how much their ad revenues will be up.