FROM OUR INVESTMENT COMMITTEE: Markets 2022: A Matter of Perspective
MODERNIST’S ASSET CLASS INVESTING PORTFOLIOS ARE STRATEGICALLY INVESTED WITH A FOCUS ON LONG-TERM PERFORMANCE OBJECTIVES. PORTFOLIO ALLOCATIONS AND INVESTMENTS ARE NOT ADJUSTED IN RESPONSE TO MARKET NEWS OR ECONOMIC EVENTS; HOWEVER, OUR INVESTMENT COMMITTEE EVALUATES AND REPORTS ON MARKET AND ECONOMIC CONDITIONS TO PROVIDE OUR INVESTORS WITH PERSPECTIVE AND TO PUT PORTFOLIO PERFORMANCE IN PROPER CONTEXT.
2022 has been yet another year filled with uncertainty. And the sources have been more varied than in years past. This should serve as a reminder to us all that the only true constant in life is change, and the same is true in the world of investing. Volatility, on average, begets more volatility, and markets have tested investors so far this year. Even so, perspective shows that it’s not all doom and gloom. Let’s unpack stock and bond markets’ performance and review why it makes sense to stick to your well-thought-out financial plan.
BOND market PERFORMANCE
Bonds serve as the foundational bedrock upon which your portfolio is built. They are meant to provide a cushion of modestly positive returns to your portfolio when stock markets are down. But due to significant interest rate increases this year, bond prices have fallen, and investors have had negative returns in both stock and bond markets. Although bonds have not been the safety net we had hoped for so far this year, performance has varied across different areas of bond markets.
The most prominent trend in the chart above is that although buying long-dated bonds can get you more yield (higher interest received for making a longer loan), they are also subject to larger price swings when rates unexpectedly rise.
Looking at the spreads in performance for short-term and intermediate U.S. government bonds relative to their longer-term counterparts, we see relative outperformance of 17.7% and 14.9%, respectively.* Those investors who chose not to extend into lower-rated bonds were also rewarded as intermediate government bonds outperformed intermediate investment-grade bonds by 3.8%.
To say this year has been a challenge for bond investors would be an understatement, but it also highlights that even though short- and intermediate-government bonds have declined this year, they’ve still been more resilient than stocks and have helped mitigate total portfolio losses.
It’s important to remember that while there is an inverse relationship between interest rate movements and bond prices, bond and stock markets have already priced in all expected future interest rate increases with all information available. And even though it’s difficult to predict future interest rate movements, it’s the unexpected rate increases that would drive bond prices down further.
There is a silver lining to this seemingly dark cloud: as rates move higher, so will the yield and expected future return on your bond portfolio. Shorter-term bonds are well positioned to reinvest their proceeds at these higher rates as they reach maturity and are replenished with new bond purchases.
Stock market performance
Like bond market performance, stocks were down—but some more than others. In the U.S., large-cap growth stocks were hit exceptionally hard. Eye-popping year-to-date losses from major technology companies like Netflix, Tesla, Facebook parent company Meta Platforms, and others were significant drivers of this market segment’s performance and the stock market as a whole. Small-cap value stocks have fared quite well in comparison, outperforming the total market and large-cap growth stocks by 5.7% and 13.7%, respectively.*
Performance has also been tough to stomach in global stock markets (see figures 2 and 3 above)
Figure 3 highlights another interesting trend: home bias—the behavioral tendency to favor investments in your home country over international investments—has not been our friend this year. This might come as a surprise to most given what has happened globally this year, but international developed markets have outperformed U.S. markets by 3%.* Those who owned international small-cap value stocks also benefited from a similar relative outperformance trend that we saw in the U.S. Perhaps most surprising, emerging market stocks also outperformed their U.S. counterparts.
BUT WHAT ABOUT MY PLAN?
Now that we’ve recapped stock and bond market performance year-to-date, what does it say about sticking to your plan and your portfolio?
First, it is a reminder that your portfolio and long-term financial plan were constructed to account for this type of market environment and many others. One aspect of this construction is diversification across geographies, asset classes, and investing styles. We tend to remember times when diversification seemingly robbed us of the extra returns seen elsewhere in markets. But that’s not really the point of diversification; it’s there to keep us in our seats as markets fluctuate on the way to meeting our long-term goals. However, as we’ve seen so far this year, diversification can also make your portfolio look better than the markets overall.
The future remains uncertain, and we’ve seen that uncertainty manifest itself in global stock and bond markets this year through a slew of macroeconomic forces that are ultimately out of our control. We don’t know if and for how long these trends will continue. But we do know that harnessing the potential benefits of diversification will provide us with the best chances of long-term success.
