Markets get real about returns

As the second half of 2022 begins, the normalization of central bank monetary policy and the subsequent recessionary fears have continued to grip consumers and investors alike. A confluence of events during the first six months challenged all markets – stocks, bonds, commodities, and currencies. Market participants had to digest COVID lockdowns, product-driven inflation, geopolitical tensions, and confusion around central bank policy that had turned quickly from dovish to hawkish.

In hindsight, the market may have been telling investors that slower growth is on the horizon and that the Fed’s policy trade-off is resoundingly clear: either break inflation or lose institutional credibility. With the specter of inflation looming throughout the economy and recession risk probabilities the new favorite statistic among investors, the market may have already priced in a moderate economic slowdown. For example, the S&P 500® Index fell approximately 20% during the first half of 2022, flirting with bear market territory. (Astute investors will remember that the S&P 500 closed at around 3,749 on June 13, 2022, to close in bear market territory officially.) History suggests, per Nationwide Economics, that “the decline in the equity market this year has been unusually large, even if an economic recession is on tap in the near-term future. The S&P 500 has never been more than 20.0 percent off its cycle high at the outset of a contraction and on average has been down by 7.6 percent from the peak when expansions have come to an end.” This might present long-term investors with an opportunity to add to a well-diversified portfolio.

As the first half of the year progressed, investor sentiment soured and equity markets plunged. To illustrate, the S&P 500 experienced the worst total return since 1962 and the Nasdaq Composite Index was down almost 30%. A wide range of asset classes (e.g., bonds, gold, emerging market bonds) saw significant losses, with the U.S. dollar and some commodities being the only positive gainers for the first half of the year. The consensus among investors for the “risk-off” nature of the market centered around recession and stagflation risks, driving concerns about future economic growth.

Of note is the persistent nature of inflation and what it means for asset performance in real terms (i.e., adjusting for inflation). This week’s chart (as seen on the previous page) illustrates how dismal the first half of 2022 was for investors when adjusted for inflation. With a negative real return of around 27%, the six-month performance was the sixth-worst real return dating back to the early 1920s. Furthermore, if the half-year real return for the S&P 500 was annualized, it would be the worst-ever year in real terms for the S&P 500, an astounding statistic that illustrates just how unprecedented market volatility has been so far this year. Nevertheless, investors should remember that markets eventually reach the bottom and that a bull market usually takes the lead after bear markets occur.