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With inflation still high, the Federal Reserve continuing to ratchet up interest rates, and both stocks and bonds falling into negative territory so far this year, is there any respite or sanctuary?
If only we had a reliable crystal ball. It’s always difficult to identify the bottom. But if history is any indication, investors trying to time the market are unlikely to come out ahead. And I’m counting professional money managers among those investors.
Think of the challenge: Not only do you have to be right on when to get out of the market, you have to be right on when to get back in. Successfully timing the stock market is near impossible, partly because the best trading days tend to cluster around the worst ones.
And missing just a few of those rally days has a surprisingly outsized impact. Looking at market data going back much further, to 1928, being out of the stock market for just the best 30 trading days would have resulted in half the return over that period.* It pays to remain invested and balanced precisely when it is most difficult to do so.
Is the United States, Europe, or China in recession today – or bound to fall into one soon – and should it matter to investors if the answer is yes?
We do not believe that the major economies are in recession today, though we believe Europe is likely to enter a mild one toward the end of 2022 and into early 2023. Our base case for the U.S. involves a relatively mild recession in the next 24 months.
It is unlikely that conditions in China would fit the formal definition of recession, but growth is likely to come in below consensus. Chinese policymakers’ willingness to enact stimulus programs and, at some point, soften their zero-Covid policy will have implications for lingering supply chain constraints and ultimately domestic and global growth. Even before the odds of recession increased, we forecast historically low returns for stocks and bonds in coming years.
All that said, because financial markets tend to be forward-looking, a recession may already be priced in. None of this negates the benefits of staying the course with an investment approach focused on low cost, balance, and diversification.
The Federal Reserve made it pretty clear that more interest rate increases are likely in the coming months. Should investors consider waiting it out on the sidelines? Everything I said earlier would apply to this question as well in spades. Over the long run, maintaining a steady, strategic approach has proven itself time and again – through periods of high inflation, low inflation, bull markets, bear markets, and a variety of business cycles.
That said, trepidation is only human during periods of volatility like this. And each individual is unique in their circumstances, finances, time horizons, and risk temperaments. Consulting an advisor who has the fiduciary duty to look after your interest is something to consider, whether it’s an ongoing relationship, a one-off session, or digital advice.
This year has been a grueling test for holders of diversified portfolios, with bond returns remaining correlated to equity returns. Have we seen a paradigm shift for the balanced portfolio?
The correlation between stocks and bonds rose this year, negating some of the diversification benefits. But that has happened on occasion in the past. More frequently and over the long run, bonds play a stabilizing role in a portfolio during periods of stock market turmoil. This remains the case independent of the level of bond yields, so proclaiming the death of the traditional balanced portfolio is premature.
Besides the diversification benefit, investors hold fixed income securities in their portfolios for a number of reasons, including income. Given the rise in interest rates, our expected returns for bonds over the next decade have increased by almost 2% since September 2021. Holding bonds makes even more sense now, and they still play an important role in a well-diversified portfolio.
There is one big upside to this down market, and it’s particularly favorable for younger investors. With the recent selloff, equity markets are now near fair value. In the fixed-income markets, while rising interest rates cause near-term pain for investors, higher rates have raised return expectations.
If you’re still in the accumulation phase of your investment life, you want to be buying at cheaper prices. Which is why, when the markets get challenging, like they are now, it’s essential that investors stay focused on their long-term goals and not get obsessed with their account balance today.
Maintaining broad diversification using low-cost mutual funds and ETFs to stay on track would be an appropriate way to take advantage of the power of compounding. Einstein once called compound interest the eighth wonder of the world. The cumulative impact of little incremental gains over time is astounding. But you won’t get that compounding if you’re not invested.
Notes
*Source: Vanguard calculations using S&P data from Macrobond, Inc., as of December 31, 2021. Based on daily price returns, the U.S. stock market returned an annualized 6.2% for the period from 1928 through 2021. If you missed the 30 best trading days, the annualized return would be 3.3%. The S&P 90 Index was used as proxy for the U.S. stock market from January 1928 through March 1957, and the S&P 500 Index thereafter through 2021. The returns did not include reinvested dividends which would make all figures higher.
Greg Davis, CFA, is chief investment officer of Vanguard Investments, responsible for the oversight of approximately $5 trillion managed by Vanguard Fixed Income, Equity Index, and Quantitative Equity Groups.
Disclaimer
© 2022 by Vanguard Group. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited. This article first appeared September 30, 2022, on the “Insights“ page of the Vanguard Group, Inc.’s website. Used with permission.
All investing is subject to risk, including possible loss of principal. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income. Diversification does not ensure a profit or protect against a loss.
Bond funds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer's ability to make payments.
Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.
Publication date: September 2022
The information contained in this material may be subject to change without notice and may not represent the views and/or opinions of Vanguard Investments Canada Inc.
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