Bear Market is Here, What to do Now – by Austin Crites, CFA
· The S&P 500 is in a bear market, down 22.50% YTD through market close 06/16/2022
· Longer duration assets have been more negatively impacted compared to shorter duration assets
· This has been caused by a number of reasons including high inflation and rising interest rates
· Investors should view the decline in asset values as an opportunity to buy at lower levels
06/17/2022
What does this mean?
US stock markets have recently entered “Bear Market Territory”. This is generally defined as a 20% drop in the overall stock market. As of the close on Thursday, June 16th, the S&P 500 was down 22.50% year to date.
Why is this happening?
In general, bear markets occur because of uncertainty around the future growth and profitability of the businesses that make up a stock market. However, each occurrence is a bit unique in the underlying causes. In this case, it starts with inflation. In the May reading from the BLS (Bureau of Labor Statistics), headline inflation was at 8.6% y/y. The federal reserve’s target for inflation is to average 2% over an economic cycle. Inflation is currently high for several reasons (labor shortages, supply chain bottlenecks, war in Ukraine, hangover from fiscal stimulus, etc.).
The key is that the federal reserve is tasked with bringing inflation down. Inflation by one definition is too much demand chasing too little supply of goods/services. They cannot control the supply chain issues or wish more oil or workers into existence so they will use their main tools of interest rates and their balance sheet to push demand down enough to tamp down inflation. This process is now in full swing as the federal reserve raised the federal funds rate to by 0.75% to 1.75% on June 15th while forecasting aggressive interest rate hikes for the remainder of the year. This makes loans more expensive reducing the incentive for people and businesses to use debt. They are also reducing their balance sheet of fixed income instruments at an increasingly aggressive pace which has the effect of pulling money out of circulation. Both of these maneuvers have the impact of crimping demand.
If the Fed is successful in reducing demand, this will likely cause an economic recession. We may already be in one (we won’t know the official start and end until way after the fact) or it may take awhile. It is possible the Fed could bring down inflation without causing a recession but if history is a guide, it is extraordinarily difficult.
What is going with investment markets?
Both stock and bond markets have declined so far in 2022. However, the pain has not been evenly shared. In January of this year, I drew attention to some valuation issues with “growth” stocks in particular.
See my post from January here: https://www.aurorafinancialstrategies.com/blog/the-stock-market-is-expensive-where-to-invest-now-by-austin-crites
“Growth Stocks” by nature are more reliant on future growth and cash flow far into the future to justify their prices. When interest rates rise, the value of those future cash flows decline due to a concept called time value of money. Read more on that here: https://www.investopedia.com/terms/t/timevalueofmoney.asp
These stocks did very well when interest rates were falling for much of the past decade but fortunes have been reversed once interest rates started rising. Fixed income investments that mature a long time in the future have seen values decline for a similar reason.
By contrast “Value Stocks” tend to be less sensitive to rising rates compared to “Growth Stocks”. They are also more likely to comprise of companies in industries that have benefited from recent events such as oil and defense.
So how have various investment categories performed? Year-To-Date through Thursday June 16th market close:
· “Growth Stocks” (Russell 1000 Growth) – Down 31.07%
· “Technology Stocks” (ticker XLK) (Technology Select SPDR) – Down 28.84%
· “Long-Dated Bonds” (ticker TLT) (iShares 20+Year Treasury Bond ETF) – Down 24.02%
· “Overall Stock Market” (S&P 500) – Down 22.50%
· “Defense and Aerospace Stocks” (ticker XAR) (SPDR S&P Aerospace & Defense ETF) – Down 17.27%
· “Value Stocks” (Russell 1000 Value) – Down 14.96%
· “Overall Bond Market” (ticker AGG) (iShares Core U.S. Aggregate Bond ETF) – Down 11.33%
· “Energy Stocks” (ticker XLE) (Energy Select SPDR) – Up 41.36%
As you can see, most of the investment universe has been negatively impacted by the macroeconomic climate year to date. The more dependent on cash flows in the future (growth and longer term bonds) were more negatively impacted than those generating near term cash flows (value and shorter term bonds) due to the interest rate increases. A handful of companies that benefit from the causes of inflation such as energy stocks have risen in value this year.
What to do now?
The good news is that lower prices generally mean better investment returns going forward. We don’t know how long the “bear market” will last. Investments may continue to decline in value for some time, but we do know they are cheaper today than they were at the start of the year. The next bull market will start at some point (we don’t know when) and those that bought at lower prices will benefit. Investors should certainly guard liquidity to protect from adverse economic impacts such as job loss or decline in income but should view price declines in the markets to be an opportunity to buy more if able.
Our overall investment philosophy holds firm. We’ll continue to position client assets where we believe offer the best mix of risk and reward but the interpretation of that will change with the markets. Volatility in the markets create distortions in price and value of investment securities and we seek to take advantage. We are currently evaluating several opportunities that may be the subject of future blog posts (stay tuned!). Our advisors are available to discuss your particular situation and how to best take advantage of the opportunities presented by bear markets.
In Summary
At Aurora, we are constantly looking for “the right pitch” in our sweet spot where we believe the probabilities are in our favor. This blog represents our thinking at the time of publication. By the time you read this, our opinion may have changed. If you are a DIY investor, use this only as a starting point for your research and be sure to do your own due diligence. For questions regarding our individual stock strategies, please reach out to us!
Invest Curiously,
Austin Crites, CFA
Austin Crites is the Chief Investment Officer of Aurora Financial Strategies, a financial advisory firm based out of Kokomo, IN. He can be reached via email at austin@auroramgt.com. Investment Advisory Services are offered through BCGM Wealth Management, LLC, a SEC registered investment adviser. This blog does not constitute advice. This is not an offer to buy or sell securities. Advisor is not licensed in all states. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. BCGM Wealth Management, LLC manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results. Clients may own positions in the securities discussed.
