The scatter plot below compares annual stock and bond returns since 1989. The dots represent the intersection of the S&P 500’s total return and the Bloomberg U.S. Bond Aggregate’s total return for each calendar year. The analysis highlights the challenging and unusual start to 2022. The ‘YTD 2022’ dot is the only dot in the lower left quadrant with stocks and bonds both declining more than -10% this year. If 2022 ended today, it would mark the S&P 500’s third worst year, and bond’s worst year, since 1989.
How unique is the current market environment? You will notice every year since 1989, except for 2022, is outside of the lower left quadrant. This indicates it is rare for both stocks and bonds to produce negative returns during a calendar year. Why are stocks and bonds declining together? The Federal Reserve is raising interest rates and shrinking its balance sheet by selling bonds, which pressures both stock and bond valuations. On the credit side, most bonds pay a fixed interest rate, which means bond prices must decline to offer a higher interest rate. On the equity side, interest rates represent the cost of money and are used as an input to value company shares. A higher interest rate typically decreases stock prices.
This year’s parallel stock and bond selloff highlights the importance of portfolio diversification not only across asset classes, but within asset classes. When you diversify your portfolio, you aim to invest in different asset classes that may react differently to the same event. The same principle applies within stocks and bonds. On a price return basis, S&P 500 Growth stocks are down -25.5% through May 11th, while S&P 500 Value stocks are only down -8.4%. In the corporate investment grade bond universe, Long-Duration (+10 Years) bonds are down -22.1% through May 11th on a price return basis, while Short-Duration (1-5 Years) bonds are only down -6.1%.
However, there may be reason for optimism amidst the volatility. This quote from JP Morgan's Weekly Market Recap from 5/16/22 (https://am.jpmorgan.com/content/dam/jpm-am-aem/global/en/insights/market-insights/weekly-market-recap-us.pdf) particularly resonated with us: "while market volatility may continue, the sell-off has brought stock valuations down to much more reasonable levels... while [corporate] earnings estimates have remained resilient. Further, history suggests that periods of gloom may be among the best times to buy equities. Indeed, following 8 rather obvious troughs in consumer sentiment over the last 50 years, subsequent 12-month S&P 500 returns averaged almost 25%. Because of this, investors would be wise to keep their emotions in check, and invest based on the logic of current valuations and long-term prospects, rather than negative emotion in this difficult time."