Investors Face 2 Serious Headwinds As Stocks And Bonds Perform Poorly In 2022

Sometimes stocks do well, and bonds underperform. Some years bonds do well, and stocks underperform. This year, both stocks and bonds have performed poorly. For investors, this makes it extremely difficult to garner a positive return. Let’s look at current conditions for these two asset classes and explore what we might expect.

Stocks

As I wrote in yesterday’s article, “U.S. Stocks Plummet Amid Worse Than Expected Inflation Data,” stocks are facing a serious headwind over the next 6-12 months. With the Fed removing the punch bowl through higher interest rates and a reduced money supply, coupled with a likely global recession, corporate earnings will fall, and stock prices could follow. The relevant question is how well will the U.S. economy hold up under these conditions?

We know corporate earnings, which are currently strong, will likely fall as the Fed continues to reduce demand to bring down inflation. If the Fed can thread the needle – meaning it doesn’t over tighten, then the U.S. economy may avoid a more serious economic downturn. However, this is a very delicate dance.

Stock prices are also subject to extreme, irrational moves, especially to the downside. We witnessed this yesterday (9/13/2022) as the DOW lost nearly 4.0% on the day. This is well above its average daily loss of 0.75%. Tech stocks did even worse as interest rates rose. So higher volatility remains. The VIX, which measures the expected risk of the S&P 500 Index over the next 30 days, has been at or above its long-term average throughout 2022. Moreover, while volatility remains elevated, stock prices face more pressure to the downside. In other words, when risk is high, stocks tend to underperform.

Bonds

Even though there are many different types of bonds, most share a common risk. When interest rates rise, bond prices fall. This year, interest rates have risen substantially across the board, placing great pressure on bond performance.

Stocks and Bonds

Let’s look at the performance of stocks and bonds this year. The following table has three sections including U.S. stocks, foreign stocks, and U.S. bonds. All performance data is YTD through September 13, 2022. The bond performance is represented by widely traded ETFs as proxies. What does this reveal?

When you compare the three U.S. stock indexes, we can say that tech stocks have done much worse than non-tech stocks. This is revealed by the NASDAQ NDAQ , an index with plenty of tech stocks in it. The S&P has more tech than the DOW, but less than the NASDAQ. In short, the DOW has performed better than the S&P 500, which has performed better than the NASDAQ. Therefore, we can conclude that tech stocks have fared very poorly this year and dividend paying stocks have done better. This may continue to hold true if interest rates move higher.

Foreign stocks have performed slightly better than U.S. stocks, but it’s nothing to get excited about, especially as cold weather sets in and Europe faces an energy crisis. Bonds have also moved lower this year. The entire U.S. bond market, represented by the first ETF on the list, is down -12.93% thus far. High yield or “junk” bonds are off nearly -14.0% so far this year. Short-term bonds, a favorite niche for investors since the 2008 financial crisis, are close to break even this year. What might we expect moving forward?

Stocks could face a tough time, especially if the Fed is unsuccessful in tightening and if a global recession has a more negative effect on U.S. corporate earnings. Bonds could go either way. For example, if interest rates remain steady or decline, bonds could move higher from here. However, if rates continue higher, bonds will continue to lose. The good news is that we may be closer to the top of interest rates than the bottom, although this is not guaranteed. So, what’s an investor to do?

Let’s try and bring all this into perspective. Even if we experience a bumpy ride, say, over the next 12-18 months, America has seen much worse in its 246-year history. We’ve had depressions, recessions, wars, pandemics and more. Even if things get rough, this too shall pass, and the American economy will once again retain its footing on the global stage. After all, the U.S. has the most resilient and diversified economy of any nation on Earth. At this point, you might make a few portfolio tweaks, but you should stick to your long-term plan and stay the course.