The first half of 2022 saw the S&P 500 decline 23.6% from an all-time high of 4,796.56 to a closing low (so far) of 3,666.77. Finishing up at 3,785.38, it’s the worst six months the Index has weathered since 1970.
More noteworthy than the extent of the decline was its gathering volatility: in mid-June, the market ran off a streak of five out of seven trading days of which 90% of S&P 500 component stocks closed lower. This is one-sided negativity on a historic scale.
But let's hold on a moment. Regardless of the points I wish to make, the most urgent is clear. Simply stated, the best way to sabotage your chance for lifetime investment success has historically been to sell one's quality stock portfolios into a bear market. The decision to sell when investor sentiment is sufficiently negative to drive 90% of S&P stocks lower on five out of seven trading days—to sell, that is, when everyone else is selling—must strike us as the height of long-term folly.
With that clearly on the record, I will try to make some sense out of what's going on here. To do so, I need to take you back to the bottom of the Great Panic on March 9, 2009. From that panic-driven ditch, the S&P 500 (with dividends reinvested) compounded at 17.6% annually for the next twelve years, through the end of 2021. At its peak this past January 3, the Index was up sevenfold from its low. This was one of the greatest runs in the entire history of American equities. Moreover, the Index's compound returns over the last three of those years—2019 through 2021 (encompassing the worst of the coronavirus pandemic) shot up to 24% annually.
But when inflation soared late last year, it became evident that equities' jaw-dropping advance over those three years had been fueled to some extent by an excess of fiscal and monetary stimulus, which was mounted to offset the economic devastation of the pandemic. In one sentence: the Federal Reserve created too much money, and then left it sloshing around out there for too long.
And since inflation, as Milton Friedman taught us, is always and everywhere a monetary phenomenon, we investors now find ourselves having to give back some of the extraordinary 2009–2021 market gains, as the Fed moves belatedly to sop up that excess liquidity by raising interest rates and shrinking its balance sheet.
Granted, the war in Eastern Europe and supply chain woes of various kinds have exacerbated inflation, but in our judgment, they are just irritants: monetary policy (seasoned with too much fiscal stimulus) got us into this mess, and monetary policy must now get us out. The fear, of course, is that the Fed will overtighten, putting the economy into recession. If an economic slowdown over a few calendar quarters is what it takes to stamp out inflation, so be it. It would be the lesser of the two evils.
Respecting our investment policy, nothing has changed: we are long-term, goal-focused, plan-driven investors. We own diversified portfolios of superior companies which have demonstrated the ability to increase earnings (and in most cases dividends) over time, thus supporting increases in their value.
We act continuously according to your financial and investment plan; we do not react to current events or the crisis du jour, no matter how distressing. After 30 months of chaos—the pandemic in its several variants, the election that would not end, roaring inflation, the supply chain mess, war in Europe and so on—we are all understandably exhausted. That is when the impulse to surrender—to get to the illusory “safety” of cash—becomes strongest, and that is when the impulse must be resisted most strongly. Our job is to help you resist that impulse.
This too shall pass. We are here to talk all this through with you at any time. Thank you for being our clients. It is a privilege to serve you.