Adviser Outlook, Third Quarter 2022 Quick Takes StocksA financial instrument giving the holder a proportion of the ownership and earnings of a company. fell into bear marketA period in which stock prices decline significantly from recent highs and remain below previous high marks for weeks or months. Generally, a decline of at least 20% in stock prices is considered the threshold marking the start of a bear market. territory (down 20% from their prior peak) in the first six months of 2022 and bondsA financial instrument representing an IOU from the borrower to the lender. Bond issuers promise to pay bond holders a given amount of interest for a pre-determined amount of time until the loan is repaid in full (otherwise known as the maturity date). Bonds can have a fixed or floating interest rate. Fixed-rate bonds pay out a pre-determined amount of interest each year, while floating-rate bonds can pay higher or lower interest each year depending on prevailing market interest rates. also declined Inflation has been taking a toll on businesses and households, sparking recession fears Stock-market declines of 20%-plus have created wealth-building opportunities for investors, with the S&P 500 index gaining an average of 17.6% over the following six months and 28.2% over the next year The market road we just traveled was bumpy—to say the least. But when you’re driving down a rocky road, while you might glance in the rearview mirror on occasion, you’re generally looking straight ahead. It’s the same with investing: We need to know what ground we’ve covered and how we are positioned, but we also need to focus on looking forward. Today, we think there’s good reason to believe the road ahead will be more rewarding than the road behind us. The Road Traveled At the end of June, the S&P 500 index was down 20.0% from year-end 2021 after falling 16.1% in the second quarter alone. Headline writers made a meal of this being the worst first half of a year since the Nixon administration in 1970. This clickbait narrative is technically true, but it misses the point—more on this below. The downturn in stocksA financial instrument giving the holder a proportion of the ownership and earnings of a company. was compounded by the simultaneous decline in bonds, which historically have helped buffer equityThe amount of money that would be returned to shareholders if a company’s assets were sold off and all its debt repaid. pullbacks. The Bloomberg U.S. Aggregate BondA financial instrument representing an IOU from the borrower to the lender. Bond issuers promise to pay bond holders a given amount of interest for a pre-determined amount of time until the loan is repaid in full (otherwise known as the maturity date). Bonds can have a fixed or floating interest rate. Fixed-rate bonds pay out a pre-determined amount of interest each year, while floating-rate bonds can pay higher or lower interest each year depending on prevailing market interest rates. index—a collection of high-quality Treasury, corporate and mortgage-backed bonds—was down 4.7% in Q2 and has dropped 10.3% year-to-date. We won’t sugarcoat it: This has been one of the worst stretches of performance in bondA financial instrument representing an IOU from the borrower to the lender. Bond issuers promise to pay bond holders a given amount of interest for a pre-determined amount of time until the loan is repaid in full (otherwise known as the maturity date). Bonds can have a fixed or floating interest rate. Fixed-rate bonds pay out a pre-determined amount of interest each year, while floating-rate bonds can pay higher or lower interest each year depending on prevailing market interest rates. market history and it has put conservative investors on edge. Markets Slump Into Summer wdt_ID Index Q2 YTD 12-month 1 Bloomberg U.S. Aggregate Bond Index -4.7% -10.3% -10.3% 2 Dow Jones Industrial Average -10.8% -14.4% -9.1% 3 MSCI Emerging Markets -11.4% -17.6% -25.3% 4 MSCI EAFE -14.5% -19.6% -17.8% 5 S&P 500 -16.1% -20.0% -10.6% 6 MSCI U.S. Broad Market -16.8% -21.2% -13.8 Note: Ranked by Q2 returns. Performance numbers are total returns, reflecting reinvested dividendsA cash payment to investors who own stock in the company. through 6/30/22. Source: Morningstar. Inflation has been stubbornly high and has taken enough of a toll on households and businesses that it’s begun to color the economic data. Consumer spending has slowed as prices for food, goods and gas have risen. Supply chain issues continue to stymie manufacturers and buyers waiting for both raw materials and finished products. Part of the issue here is a labor shortage; job openings in the U.S. are at an all-time high in numerous markets. The ongoing war in Ukraine has only stressed the global system further. The Federal Reserve, late to the inflation-fighting game, has acted aggressively this year by raising the benchmark fed funds rate at three successive meetings, including a 0.75% hike in June—the largest interest-rate hike since 1994. Central bankers are expected to keep hiking over the next six months. Forecasts are for the key lending rate to reach the 3.50%–3.75% range by year-end. Rate hikes have a range of repercussions, but the intent is to induce consumers and businesses to spend (or borrow) less and save more, reducing demand. Lower demand should in turn result in lower prices for goods and services. The question is whether the Fed can engineer this slowdown without throwing the economy into a recession. Even Fed Chair Jerome Powell has some doubts the central bank’s policymakers will be able to thread this needle successfully. The picture is mixed when it comes to recession—some pundits think we’re already in one, others think we’re not quite there and a third group predicts we’ll avoid one altogether. The economic data over the past month has (on balance) come in worse than expected, pointing toward slower growth at best. Wherever we end up, keep two points in mind: First, the past two recessions, resulting from COVID-19 and the global financial crisis (also called the “Great Recession”), were particularly severe. The next one doesn’t have to be as harsh. Second, recessions are based on trailing data—meaning that by the time it’s “official” we’re already months into or through a recession and stockA financial instrument giving the holder a proportion of the ownership and earnings of a company. markets have priced in the slowdown (at least to a degree) long before the recession declaration. Throw in dramatically higher mortgage rates, record high home prices and continued outbreaks of COVID-19, and it’s no wonder that consumer sentiment has been depressed. According to a University of Michigan survey, consumers are more negative today than at any time in the past 50 years or so. Yes, even more pessimistic than during the financial crisis in 2008, the dot-com bubble burst of the early 2000s and all other major upheavals dating to the early 1970s. Our Outlook Markets bottom ahead of economic data—we think we are closer to a market bottom than the top Stocks are on sale relative to where they were at the start of the year and fixed-income assets are offering higher yieldsYield is a measure of the income on an investment in relation to the price. There are several ways to measure yield. The current yield of a security is the income over the past year (either dividends or coupon payments) divided by the current price. This is an opportunity to review (or create) a financial plan to make sure you’re on track to reach your goals, to work with us to make any necessary adjustments or to take advantage of portfolio losses to lower your tax liabilityLiabilities are calculated by adding up your existing debts (mortgage, car loans, student loans, credit cards, etc.). The Road Ahead Take a break from driving and you’ve only lost a bit of time—no harm, no foul. Take a break from investing (and sit in cash) and you could be making the classic mistake of buying high and selling low. The time to go to cash was six months ago, not today. We know how discouraging it is to see the value of your investments fall by double digits—for most of us, the pain of a loss is twice as intense as the joy we experience from a market gain. Though markets could still fall further, the data suggests a bright side to periods like this. Since the S&P 500 index’s 1957 inception, there have been 13 six-month periods when the index fell by 20% or more (not including the past six months). In the six months after 20%-plus drops, stocks have averaged 17.6% gains. Stick around for a year after a deep decline and the S&P 500 was up every single time, on average by 28.2%. Note: Table shows all six-month declines greater than 20% for the S&P 500 index (excluding reinvested distributions) from March 1957 through June 2022 along with index-level returns for the six months and 12 months following. “Average” is the average of the data displayed in the table. “Average All Periods” shows rolling average six- and 12-month returns from March 1957 through June 2022. Sources: Morningstar, Adviser Investments. Even if now is not the absolute bottom in terms of stock prices, the table above provides some insight into what happens when you buy “early.” For instance, if you bought stocks at the end of 2008, yes, prices fell another 18.6% over the first two months of 2009. But even with those declines factored in, you still made 23.5% (not including reinvested distributions) over the course of calendar-year 2009. Point being, you can still compound at an attractive rate over time without timing the bottom. It’s a similar story when consumer sentiment sinks to lows. Since 1971, sentiment has bottomed out eight times and the average price return for the S&P 500 during the subsequent 12 months was 24.9%. In other words, following periods like this, patient investors have been amply rewarded. Whether we are at an inflection point or will have to wait a while for a market upturn, we’re not recommending wholesale changes in portfolios or financial plans based on either the markets or the economic outlook. Note: Chart shows gains from troughs and declines from peaks for the S&P 500 index (excluding reinvested distributions) from 10/23/57 through 7/7/22. Source: S&P Dow Jones Indices. Just as investors have been rewarded for keeping money in the stock market after 20%-plus pullbacks, they’ve suffered an opportunity cost when trying to time market bottoms. The average bull marketA period during which stock prices rise significantly from recent lows for weeks, months or years. runs for about five years and returns 158%. By contrast, the average bear market lasts a little over a year, with an average decline of 36%. The average return one year after stocks bottom? 43%. As for the bond market, our message is the same: The time to avoid bonds was six or 12 months ago. But looking at the opportunity today, well, we’re earning more income than we were a year back. That higher income will, with time, make up for the recent decline in prices. If bonds made sense as part of your plan at the start of the year, they still have a role to play today. This isn’t to imply that you should close your eyes and just hang on—there may be more potholes ahead. We discuss time-tested actions you can take during bear marketsA period in which stock prices decline significantly from recent highs and remain below previous high marks for weeks or months. Generally, a decline of at least 20% in stock prices is considered the threshold marking the start of a bear market. in our “Practical Steps to Beat the Bear” podcast episode. In taxable accounts, you may have noticed we’ve engaged in what is known as tax-loss harvesting. This is where we sell shares at a loss and swap into a similar investment. This allows us to maintain exposure to the market while realizing losses that can be used to offset future gains. Simply put: Bear markets do have silver linings, allowing us to help you save on your taxes. If you are worried that your plans to retire are in jeopardy or if you’re in retirement and wondering if you can still live the lifestyle you want, this is the perfect time to revisit or create a financial plan, which we consider the GPS that will help you navigate toward your goals. All of our financial plans are built with the knowledge that there will be rough stretches on the road. We have decades of experience getting clients safely through those patches. We know that seeing your account values decline can be emotionally difficult, but we believe that wealth-building opportunities are created in times like these. If you have cash to invest or want experienced wealth managers to help navigate market and economic uncertainty, we’re here to talk about the best ways to do so. Personal Finance Focus: Roth IRAs—Why Now? Roth IRAs have become increasingly attractive recently and it’s worth examining if you would benefit from a conversion. The key difference between Roth IRAs and traditional IRAs is that traditional IRAs are tax-deferred: Money invested in a traditional IRAA type of account in which funds can be saved and invested without being subject to tax until the account holder reaches retirement age. is not taxed until it is withdrawn, at which time you pay at your normal income tax rate. When moving funds into a Roth IRA from a 401(k) or other retirement account, tax is paid at the time of the transfer. You can also open a Roth account with your own savings. Once deposited in the Roth, your investments grow tax-free. (Withdrawals made before age 59½ are penalized for both Roth and traditional IRAs.) What makes this a particularly good time to switch from a 401(k) or traditional IRA to a Roth? First, a law passed in 2019 makes it far easier (with less of a tax burden) to pass a Roth IRA on to heirs compared to a traditional IRA. Second, we’re in the throes of a bear market. It’s painful seeing the value of your portfolios decline—but acting now could help you save on taxes by converting at or near a low point for your holdings. There are two caveats to consider: If you don’t have enough cash on hand to pay the taxes due at conversion and would have to sell some of your holdings to cover them, you’d be locking in your losses. And if you may need to tap into your funds for living expenses in the medium term—say in the next five to seven years—your portfolio may not have recovered sufficiently to make a conversion worthwhile. Give us a call if you have questions about your situation. We’d be happy to help. Company News: Welcome to Our New CEO, Mario Ramos! Earlier this summer, we announced that Mario Ramos had joined Adviser Investments as our chief executive officer. We wanted you to hear from him directly. “I’m a banker by training, so I’ve been in this industry for most of my working life. That said, the common thread across my career has been prioritizing the needs of clients. I believe in our mission and the fiduciaryA person or organization who manages assets for a third party, and is legally bound to act in the best interests of that third party, putting the third party’s interest before their own. responsibility to offer the absolute best service. I’m also excited to lead and guide this organization at a time when growth is a key priority. As always, our corporate values of honesty, integrity and personalized client care will be essential to that growth.” —Mario Ramos This material is distributed for informational purposes only. The investment ideas and opinions contained herein should not be viewed as recommendations or personal investment advice or considered an offer to buy or sell specific securities. Data and statistics contained in this report are obtained from what we believe to be reliable sources; however, their accuracy, completeness or reliability cannot be guaranteed. Our statements and opinions are subject to change without notice and should be considered only as part of a diversified portfolio. You may request a free copy of the firm’s Form ADV Part 2, which describes, among other items, risk factors, strategies, affiliations, services offered and fees charged. Companies mentioned herein are not necessarily held in client portfolios and our references to them should not be viewed as a recommendation to buy, sell or hold any of them. Past performance is not an indication of future returns. Tax, legal and insurance information contained herein is general in nature, is provided for informational purposes only, and should not be construed as legal or tax advice, or as advice on whether to buy or surrender any insurance products. Personalized tax advice and tax return preparation is available through a separate, written engagement agreement with Adviser Investments Tax Solutions. We do not provide legal advice, nor sell insurance products. Always consult a licensed attorney, tax professional or licensed insurance professional regarding your specific legal or tax situation, or insurance needs. © 2024 Adviser Investments, LLC. All Rights Reserved.