For investors, the first half of 2022 has been bleak. Inflation appeared seemingly out of nowhere to become a major economic problem. A surprise war in Europe added to global uncertainty and supply chain shortages. Recession anxieties surfaced. And stocks and bonds took it on the chin.
There are signs of improvement, or at least stability, in the second half. For stocks and bonds to move forward, these five topics and trends could be crucial.
The upcoming midterm elections promise more political rancor and division, but eliminating them should help the stock market.
“One of the things we knew going into this year was that 2022 will be a mid-term year – and those have historically not been good for equities,” noted a comment from LPL Financial.
Since 1950, the mid-term years have produced the weakest market performance in the four-year cycle, with stocks in the Standard & Poor’s 500 index falling 17.1% on average, from peak to trough, during of these periods. A pullback of this magnitude has already been surpassed in 2022, with the S&P 500 falling 23.5% earlier this year.
Whether or not we saw the bottom of the market this year, the good news is that stock prices are eventually recovering.
A year after mid-term lows, stocks are up an average of 32% from those lows, according to LPL Financial. In the years following the midterm elections, the market has seen gains every time since 1950, or 18 out of 18. The next such year is 2023.
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Beating Headline Inflation
Soaring inflation is the economic story so far in 2022, prompting the Federal Reserve to raise interest rates, undermining business and consumer confidence, eroding Americans’ purchasing power and driving down stock and bond prices. This new inflation trend follows years of rather moderate increases in the consumer price index.
“Analysts (like us) have repeatedly called for inflation to peak over the past 18 months, to be wrong,” the Northern Trust economists wrote in a mid-year comment.
Inflation is unlikely to come down anytime soon, not with ongoing supply chain issues, disruption from Russia’s invasion of Ukraine, 11 million unfilled job vacancies and other catalysts .
But it’s important to remember that high inflation was historically more the exception than the rule. Consumer price increases above 4% to 5% are unusual, and there are many reasons to expect the trend to subside by the end of the year.
Among these catalysts cited by Northern Trust: energy prices have fallen from their recent highs, transport costs have fallen sharply and monetary policy has rapidly become more restrictive. Additionally, inventories are piling up, reflecting increased pressure against retailers and suppliers raising prices, and layoffs are starting to rise again.
Waiting for a possible recession
Inflation looks set to come down sooner or later, which would support financial markets. The question is whether a recession is necessary to get the job done. The jury is still out on that one.
With many economic indicators still strong, a recession may not materialize for a few years. Conversely, we could already have arrived.
Either way, recessions or economic contractions are a normal part of the cycle, and they’re usually not that severe or that long-lasting. The most recent, in 2020, lasted only a few months, although it was brutal.
“National income and job losses are modest” in most cases, according to the Northern Trust commentary. “If that’s the price to pay to fix inflation in the long run, it could very well be worth the cost.” During recessions, laid-off workers bear much of the brunt, but any downturn in the months ahead would start with low unemployment.
The stock market will likely bottom out before a recession ends and, perhaps, before it is officially declared by the National Bureau of Economic Research. Investors look to the future, anticipating the eventual recovery, while statements of recession come in hindsight, often months after the worst is over.
Obtain a bond price cushion
Diversification is the idea of not putting all your eggs, or investments, in one basket. The idea is to ensure that you always have assets that are going up or holding steady while others might go down. It’s an intuitive concept that has worked well over time.
One of the key tenets is that you want to hold assets with varying degrees of risk – in particular, you want certain bonds or bond funds to compensate for the higher volatility of stocks and equity funds. Equities have largely outperformed fixed income investments over time, but their higher returns come in spurts, not fluids.
“Over the years, bonds and stocks have played complementary roles in portfolio management, the foundation of which is diversification,” wrote Jack Ablin, chief investment officer at Cresset Capital Management, in a recent report.
From 1976 to 2021, stocks represented by the S&P 500 index fell in eight calendar years, and each time the bond market gained to dull the pain, Ablin noted. But that hasn’t worked lately, with stocks and bonds stumbling in the first half of 2022. Bonds’ roughly 11% drop in the first half of the year overall could be more notable than the 21% decline in stocks. .
But with bond prices now falling and yields rising — they’re moving inversely — bonds are likely closer to fair value than they were at the start of the year, according to Ablin. This should allow them to resume a more normal diversification role, helping to cushion the often wild swings in the stock market.
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Some legislation could also support stock and bond markets, for example by making pension schemes more attractive and accessible. If so, the Secure 2.0 Act might be the best bet for enactment over the rest of 2022.
The Securing a Strong Retirement Act of 2022 would update various savings rules, such as increasing participation in retirement plans and delaying the deadlines by which investors must begin withdrawing money from retirement accounts, noted the American Council of Life Insurers. The bill passed the House in March by a solid 414-5 margin, but is still awaiting final action in the Senate.
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A provision would delay the required minimum distributions, or RMDs, of individual retirement accounts and 401(k)-style plans to 75 years, from the current 72 years. Congress extended the age threshold to 70½ with the passage of the first Secure Act in 2019.
In addition, the legislation would require automatic enrollment of most new workers in 401(k)-type retirement plans, reduce plan administration costs for small businesses, and improve retirement savings credit, a tax break offered to low-income workers that essentially provides a source of matching funds from the federal government.
Other changes could improve the use of annuities in retirement planning and make workplace pension plans more widely available to part-timers, military spouses and student borrowers. It’s hard to plan bipartisan action in an election year, but this one could do it.
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