After reaching new highs in 2021, with the S&P 500 (SPY) returning almost 29% and the NASDAQ 100 (QQQ) returning about 27.5%, the market turned in 2022. The S&P 500 and NASDAQ 100 are down 13.2% and 25.8%, respectively, so far in 2022. Much of what has happened in 2022 is a reminder of the fundamental rules of investing, but there have been a few surprises.
One of the surprises for many investors is the degree to which bonds have fallen along with stocks. Broad bond indexes have fallen almost as much as the S&P 500. The iShares U.S. Aggregate Bond ETF (AGG) and the Vanguard Total Bond Market ETF are down 11.5% and 11.7% (respectively) for the YTD, for example. While bonds tend not to move with stocks, the long-term correlations between major stock and bond indexes are low but not substantially negative. This means that bonds and stock tend to move largely independently of one another, but not in opposite directions. Also, the long-term statistics may not be applicable to any specific year’s conditions. This year, the decline in share prices has largely been driven by rising interest rates, which also push bond prices down. The benefits of diversification manifest themselves over long periods, but may not be evident in any given year.
This has also been an important year for reminding of the dangers of performance chasing and putting faith in the abilities of the latest star fund manager. For this year, the teacher has been Cathie Wood, whose flagship fund (the Ark Innovation ETF, ARKK) is down 60% so far in 2022. The fund now substantially lags major stock benchmarks over the past 5 years, after gaining huge amounts of assets from investors when the fund returned more than 150% in 2020.
Another thing to remember from 2022 is to pay attention to the long-term mechanics of markets and not get swept up in the latest narratives. The current turmoil with cryptocurrencies and FTX are the key example currently in the news, but there are quite a number of others. Low interest rates finally had the their traditional effect of inflating asset bubbles and driving inflation. Over extended periods of time, markets cannot have the benefits of low interest rates in encouraging investment without the mirror effect of high inflation and prices. Simply put, if something seems too good to be true, it probably is, and if something defies the historical workings of markets, it will probably reverse at some point.
This year has been a reminder of the huge power of demographics. Large numbers of baby boomers retired during and after the pandemic, shrinking the workforce and contributing to a labor shortage (also see here). This, in turn, drives down the unemployment rate so that employers must offer higher wages to attract workers. Higher wages add to inflation. There is only so much that raising interest rates (or any other intervention) can do to offset this demographic trend. The longer-term impact of an aging population is lower economic growth. This is partly due to a lower labor participation, as well as the simple reality that aging workers tend to be less productive.
As inflation has skyrocketed in 2022, we either learned or re-learned that the effects of inflation are highly personal. If you own a home, either outright or with a fixed rate mortgage, you have not experienced a substantial increase in housing prices. If you don’t drive much or have an electric car, high gas prices are not a significant problem. This issue is of particular importance for financial planning. If you have a higher personal inflation rate, you will need to accumulate a larger nest egg.
The pandemic years have also reminded us how susceptible markets are to short-term thinking. Zoom Communications (ZM) was a huge beneficiary of work from home, as were companies like Teladoc (TDOC) and Peloton (PTON). The market enthusiasm for these companies drove the share prices to incredible levels, even though logic indicated that their growth would be curtailed as the pandemic waned.
A related issue that 2022 has highlighted is that even really awesome companies can be way overpriced. A significant number of the companies that I have written about this year fall into this category (TDOC, TSLA, SNOW…). During the pandemic run-up, the market seems to have forgotten that the value of a stock must ultimately be justified with earnings and many investors seemed to believe that no price was too high for their favorites.
There is no question that 2022 has been a challenging year for many people. Even so, there is useful learning that accompanies the difficulties. In many ways, this year has seen a return to rationality that seemed to have been suspended during the the worst of COVID and the aftermath. The unusual forces at work in recent years also highlight important situations that we have tended, as a society, to ignore. While energy prices were very low for years, it was easy to get complacent about where our energy comes from, for example. Similarly, the increasing average age in the United States has been obvious for years, but 2022 reminds us of the important shifts that are occurring.
Geoff Considine on Finance and Economics 