Several events have contributed to the recent market downturn, including persistently high inflation, a dramatic change in monetary policy by central banks and the economic fallout from Russia’s invasion of Ukraine.
Like many people, you may be concerned about how the current market situation is impacting your portfolio and wondering what, if anything, should be done to “fix” it.
We want to personally reassure you that for the majority of our clients, the right thing to do is to stay the course. While investment returns are not guaranteed, and historical returns are not an indication of future results, market corrections like the one we’re currently experiencing are expected occurrences and your financial plan was designed with this in mind. Consider the significant market downturns of 2001, 2002 or 2008: back then, many investors were similarly worried and wondering what to do. Those that stayed invested fully recovered and later saw markets hit an all-time high in December 2021.
The impact of previous downturns
Since 1950, there have been nineteen economic downturns precipitated by negative international events. On average, each of these events resulted in a market decline of -22.8% and took 15 months to recover. One year later, the average return was 31.5%. Two years later, it was 45.1%. Historically, staying invested allowed individuals to take advantage of market recoveries.
For more details, see https://efgi.com/wp-content/uploads/2022/02/Market-Recoveries.pdf.
The above “trend channel” charts are based on a regression analysis of the past five years’ returns for the S&P 500 and the S&P TSX. In the case of both markets, December 2021 performance was at or near the top of the channel while recent performance was at or near the bottom. The trendline itself has an upward trajectory that falls between these high and low points.
Are we in a recession?
There are indications that we may be in or heading into a recession. For one thing, we are currently seeing an inverted yield curve, an uncommon economic event wherein short-term interest rates exceed long-term rates. Economic cycles have historically transitioned from growth to recession and back again. Inverted yield curves are an essential element of these cycles, preceding every recession since 1956. In addition, when inflation is high and central banks are working hard to quell it by increasing interest rates, as they are now, it can be difficult to achieve a “soft landing” whereby inflation is brought to heel without economical growth being negatively impacted.
So, how have stocks performed when the economy has faced a recession? Surprisingly, the S&P 500 rose an average of 1% during all recession periods since 1945. That’s because markets usually top out before the start of a recession and bottom out before its conclusion. In almost every case, the S&P 500 has bottomed out roughly four months before the end of a recession and hit a high seven months before the start of a recession, which lasts an average of seventeen months in the United States.
Bonds versus GICs
Although bonds generally serve as a buffer that insulates investors from the volatility in their stock holding, they have not performed that function well this year. The culprit for the sharp decline in bond values is the rise in interest rates that accelerated throughout the first half of 2022 as inflation soared. Bond yields and prices typically move in the opposite direction. Therefore, their value will fluctuate on your statements — funds that invest in bonds will fall in a rising interest rate environment such as the one we’re in now.
When you invest in a Guaranteed Income Certificate (GIC) you get a guaranteed return at the term’s end, as you do with bonds, but you don’t see the value fluctuation during the holding period. At this time, we are seeing the highest rates on GICs in 20 years and with the Bank of Canada expected to continue to raise rates in order to battle inflation, it is likely that rates will climb even higher.
It is important to understand that even at these higher rates, GICs won’t outperform inflation, which means that you’ll lose purchasing power over time. That said, GICs can be a good option for individuals who need money within a short timeframe and cannot afford to lose even one dollar, and also for those who are not willing to take risk because they do not like seeing their investments fall in value.
The Bottom Line
No one can predict where the bottom of the market is, but historically, markets have recovered. Days of strong market growth often closely follow days of decline, and as you can see from the article “What Happens If You Miss The Best Days In The Stock Market” (https://efgi.com/what-happens-when-you-miss-the-best-days-in-the-stock-market/), a handful of days generally make up the majority of the annual rate of return.
Although staying the course is the right decision for most clients, we have two additional recommendations for your consideration:
- Historically, the average market downturn lasts approximately fifteen months. If you know that you will need to generate income from your portfolio over the next 12-18 months, you may want to consider withdrawing the required amount now and leaving the remainder invested to recover.
- If you have a non-registered (open) account, the current market downturn may offer a tax-loss selling opportunity. Capital losses can be carried back three years and carried forward indefinitely and can be used to provide substantial recovery on taxes paid on capital gains. Please contact our office in October or November of this year if you reported capital gains in 2019, 2020 or 2021 on line 12700 of your tax return and would like to undertake tax-loss selling.
Our team sincerely appreciate your business and we will continue to work hard for you through this challenging time. Please contact our office if we can be of assistance in any way.