Can things get much worse this year than they are right now? According to the world, it’s guaranteed that they will! The hot takes have written about the market’s demise already. We must admit, stocks (and bonds) are doing worse than we expected. During any given year, it’s normal to think stocks can fall about 15%, but it’s the market’s inability to bounce back from this current decline that has been most challenging.
Is it time to move to cash?
If you’ve stomached this painful drop in stocks thus far, now is probably not the time to raise cash. Outside of recessions, stock market pullbacks are typically capped around 20%. At last week’s low, the current decline reached 19%. If a recession isn’t imminent, the S&P 500’s downside could be pretty limited.
What if we are on the verge of a recession? Data dating back to 1938 shows that the S&P 500 has lost an average of 32% (median 27%) leading into and during recessions.
During recessions in the 1940s and early 1980s, two periods marked by sustained inflation, the S&P 500 lost 21% (1949), 17% (1980), and 27% (1982). By those comparisons, the market’s decline may already be more than two-thirds of the way complete. Of course, stocks fell much further following the dot com bubble and the housing bubble, dropping 49% from 2000-2002 and 57% from 2007-2009.
Another piece of data against raising cash at this point is that stocks have historically posted strong returns in the 12 months following a 15% drop, rising an average of 18.6% (median 20.4%) and posting positive returns in 24 of 26 instances. Selling now risks missing out on the potential rebound.
What if things are to get worse
We are in the glass-half full camp, but that’s been a bitter tasting glass to be drinking from so far in 2022. While we don’t expect the current decline to morph into something dramatically worse, it’s always a possibility. Strategically, for investors who are very nervous about a further drop in the market, you do have some options.
Short-term bonds, both on the government and corporate side, are offering their highest yields in years. Vanguard’s short-term treasury ETF, VGSH, is currently yielding 2.55%. IGSB, a short-term corporate bond fund, is yielding 3.60%. These ETFs are down 2.70% and 5% on the year, faring significantly better than stocks and most blended bond funds. PFXF, a preferred stock ETF which yields nearly 6%, is down 15% over the last six months since interest rates started to rise. A similar decline in 2018, amidst a similar interest rate environment, saw PFXF fall 17%. We like the risk versus reward in PFXF right now.
Ultimately, the posture one is taking in the market right now greatly depends on their stage of life. Retirees, or those nearing retirement, have legitimate reasons to be concerned. However, those with 10-20 years or more remaining in their investment timeline are best served doing one of two things right now:
- Nothing – often times doing nothing proves to be a good decision.
- Taking advantage of the decline in stocks (and bonds) to increase your exposure to assets that can tangibly increase your net worth in the future.
A final note
During the ongoing pullback in markets remember that it’s often the unknown that is most concerning; fear is always worse than reality. The media feeds off of this fear. By encouraging fear, the media can earn more clicks and increase user metrics, which can be a boost to their bottom line. Neither traditional media nor social media are looking out for your best interest when it comes to their hot takes on the market.
Keep in mind, based on historical statistics, at this point in the market’s pullback, more than the worst has likely already occurred. Furthermore, declines like this one have often been followed by meaningful recoveries over the next 12 months. There’s no guarantees in this business, but one thing is for sure: making decisions out of fear is rarely a winning strategy.
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