In the last few months, both equities and bonds have taken quite a drubbing. Some of the stats are truly eye-opening:
- The Russell 3000, which comprises U.S. small cap stocks, was down 18% from its all-time highs as of May 10. Meanwhile, some of its components have fallen even more. Well-known blogger Ben Carlson of A Wealth of Common Sense noted that 1 in 5 stocks in the index were down 80% or more from their peak.
- Bonds have not been a safe haven as equities have been sold, with the Bloomberg Aggregate Bond Index down 10% year-to-date as of May 10. To put this in context, Carlson points out that the worst year for this index since its inception in 1976 was 1994. For that year, bonds only suffered a 2.9% decline.
The Reason This Time Around
When market volatility spikes, there’s usually something that sparked the decline. In this case, the rout seems to be tied to fears of inflation. Consumer price increases—influenced by supply-side disruptions (think the pandemic) and commodity price increases (think Russia’s invasion of Ukraine—have led central banks to become much more hawkish than bond investors expected. Expectations of rising interest rates have hurt bond prices. Equities, meanwhile, have suffered from these rising yields, as well as the air coming out of some wildly overvalued stocks.
Looking on the Bright Side, Part 1
There are reasons to believe that some of the catalysts for the recent volatility could abate. We remain hopeful of an eventual peaceful resolution to the events in Ukraine, first for humanitarian reasons, but also because that could lead to lower inflation pressures. That, in turn, could lead to a bond rally which would also support equities.
In addition, the U.S. consumer is in good shape for the most part, other than having to endure higher gas and food prices. The unemployment rate remains very low, wages have increased, and household net worth is estimated to have more than doubled since 2008. With the consumer accounting for approximately 70% of the U.S. economy, they remain, at least for now, a notable bright spot.
Looking on the Bright Side, Part 2
It’s important to note that active management is essential to avoiding the worst of these declines. In this vein, we have avoided owning stocks such as Zoom and Peloton, which were trading at silly valuations and are now down 70-80% from their highs. Passive investors, who owned these stocks simply because they were in an index or ETF, weren’t so lucky.
Looking on the Bright Side, Part 3
When the market is experiencing a large decline, it can feel like a permanent one. But as this chart shows, S&P 500 Index Expansions and Downturn Periods (Since 1945) historically pullbacks have always been temporary. As importantly, the rebounds that have followed have been longer and stronger than the setbacks that preceded them.
Being impossible to ‘time’ markets, our portfolio managers remain focused on owning the best businesses that can weather a slowing economy and that will thrive when things recover. Opportunities present themselves as everything sells-off, and our teams are ready to buy their highest conviction stocks.
Volatility isn’t fun, but as we’ve said before, it’s the price long-term investors pay for solid long-term returns. So don’t be too disheartened—better days are ahead.