Let’s be realistic, there isn’t enough “lipstick” we can put on this market. It’s been disappointing to say the least in the first four months. We suspect it should be down for most of the year. Maybe recovering in the late fall. We would not be surprised of further market volatility and the S&P 500 dropping to its May 2021 low of 4100 before it starts to recover – given the following:
- The Fed attempting to fight inflation by raising interest rates four more times this year at .25% to 0.5%,
- Supply chain issues especially since China has just closed Shanghai ports, and
- The war in Ukraine questioning most of the things affecting such commodities as oil and gas.
We have become accustomed in recent years to the market recovering quickly as it did after the December 2019 correction and March 2020 due to the pandemic. We forget that it took much longer for the markets to recover after the Great Recession over 15 years ago.
When faced with such a volatile year, we find ourselves in discussions over market timing attempts to protect capital by moving to cash and abandoning Modern Portfolio Theory (MPT) which is the study of investing based on risk tolerance between fixed (bonds) and equities (stocks) which calls for periodic tactical adjustments.
Here’s some things to consider in discussing capital preservation vs. “white-knuckling” the current market:
- The S&P 500 has corrected 13% so far in 2022. The average correction (since 1980) has been 14%
- Since 1980, 21 years have corrected at least 10% at one point during the year, and 12 of those years have managed to come back positive to the tune of about 17% on average. Yes, large reversals are possible such as the 2020 drop to 2021 surge.
- This is a mid-term year, which historically are volatile which also means the market tends to find bottom later in the year. The good news is stocks then to recover about 30% a year off those lows.
While we still fundamentally believe MPT is the key for long-term financial success, some might benefit from understanding what types of fixed instruments are available.
- Corporate Bonds: Historically bonds with long-term maturities decline in value when interest rates rise to include reinvestment of dividends. Alternatively, short-term bonds and floating-rate bonds have lower risks but also have lower yields.
- Certificate of Deposit (CDs) and annuities: Currently the yields on these instruments are rising, so short-term CDs or annuities that can be reinvested might make sense. This tactic is usually known as “laddering.” The concern is keeping up with inflation.
- Money Market Funds: Main objective is to provide liquidity in the short-term while protecting your capital. However, considering the current rising inflation climate, it is doubtful they will keep up with inflation either, especially after taxes. Generally, best use is for short, 1–2-year goals.
- Treasury Bills and Notes: For short-term investments you can purchase treasury bills directly from TreasuryDirect.gov. Six or 12-month treasury bills with current yields range from about 1.2% (6mos) or 1.7% (12mos) bills. Other treasury options are two-year bills yielding about 2.3%. Like CDs, there usually is an early withdrawal penalty.
- I-Bonds: These are becoming the new standard for capital preservation. A Series I Bond has significant advantages as well as disadvantages over other Treasuries or fixed instruments. You can only invest in I-Bonds through the U.S. Treasury at TreasuryDirect.gov. Currently and for the next 6 months, they yield 9.62%. The rate adjusts every six months based on Consumer Price Index (CPI) and is averaged over the time they are held. They must be held for 12 months but if sold in less than 5 years, like CDs, you lose three months of interest. The maximum purchase for individuals is $10,000 and for married couples it’s $20,000 per year. You can also make up to an additional $5K purchase per year with a tax refund.
Of course, the primary concern in these fixed instruments is keeping up with inflation. Years of experience strongly suggest that MPT designed around your long-term risk tolerance is the best investment strategy for most clients. Please give us a call if you have questions, concerns, and/or feel your risk tolerance over the next 5-10+ years should be more conservative than our previous discussions.