Most of the time, stocks and bonds have an inverse relationship, meaning when stocks rise, bond prices fall, or at least rise at a significantly slower pace and vice versa. This allows for a nice counterbalance to risk in portfolios and is the cornerstone of broader asset allocation decisions.
In 2021, bond prices showed weakness. This made sense as the Fed announced plans to begin raising rates in early 2022 and to continue doing so throughout the year. As we were working our way out of the pandemic, supply chain issues and historically low unemployment causing labor challenges, this made good sense to help slow inflation which was and has continued to reach recent highs.
In a diversified portfolio, this drop in bonds was offset as expected, with stocks picking up impressive returns in most asset classes for 2021.
The first quarter of 2022, however, has been no ordinary time.
The market had strengthening headwinds to start the year that weren’t as present in 2021. The omicron variant delayed our return to some sense of normalcy, extending supply chain constraints and causing Inflation to continue its rise. Housing market supplies remained low, labor shortages persisted and tensions between the U.S. and China were front page news.
Many of these concerns continued to put pressure on bonds and we started to see some volatility in certain areas of the stock market, while other areas, such as large international companies, thrived.
Then came Russia’s decision to viciously attack Ukraine. While this has brought the EU, NATO, the US and other allies closer strategically than they’ve been in years, the devastation caused in Ukraine and to its people has spread to markets.*
As of the writing of this blog, the S&P 500 is down 4.35% for the year and BND, an ETF that tracks the U.S. Aggregate Bond index, is down 6.05%. For a few seconds over multiple days last week, 2-year bond yields were higher than 10-year yields. This is sometimes a sign of a recession to come, but could also simply signal an expectation that rates may come down a bit after the Fed spends a few years trying to find the right balance to control inflation.
Regular readers of the blog will know that I’m not about to predict where we head from here. As mentioned above, the Fed’s trying to pull off a very difficult feat of cooling down rising prices without slowing growth to the point of recession. On top of that juggling act, the crisis in the Ukraine and its eventual outcome are still highly volatile and uncertain.
What we do know is that in years where the stock market started the year poorly as it has this year, it ended the year positive 78% of the time. We also see consumer sentiment as low as it’s been since 2011 which, while that sounds negative, is typically a precursor to improving markets.
None of what’s been described in terms of market impact is all that unusual. While diversification is the best tool we have at mitigating portfolio risk, it’s not a cure-all. In volatile markets, asset classes tend to move more closely together than in less volatile times.
We don’t plan for these events in the midst of troubling times. Instead, we build portfolios and plans to be resilient through virtually all markets, confident in the knowledge that over 5, 10 and 20-year periods and beyond, stocks and bonds will go up despite what happens in shorter cycles.
If you have any questions about how inflation, rising interest rates or other world events is currently impacting your situation, feel free to reach out to your advisor.
*Sidenote – it’s worth mentioning that it is always difficult to discuss markets in times of war. The human tragedy and senseless destruction of families, homes, and cities are far and away the foremost issues related to these events. But, as asset managers, we must also make the difficult transition in evaluating and discussing how these global events impact markets and, in turn, the financial lives of those we serve.