As this year draws to an end, let’s look back at what actually happened and whether or not we can expect it to happen again. 2022 has been a really bad year for bonds with the Bloomberg US aggregate bond index down 13% at the end of November. Now to put that in context, the index has only had four negative years since 1976 with the lowest total return being just negative 3% in 1994. Bonds are supposed to be a safe investment. So what happened this year. The answer is inflation. Inflation spiked to levels not seen in over 40 years, and that forced the Fed to drastically raise interest rates and higher rates mean lower prices for bonds. Now, to be clear, inflation was higher in the 1970s, but this time around the Fed acted swifter and stronger. You see from the mid 70s to the early 80s, interest rates doubled in about eight years.
This time around they more than tripled in less than two years, and speed kills layer in some slowing. Economic growth and profit margins get squeezed hurting equity prices. If we use the s and p 500 as a proxy for the stock market, this would mark the first year that stocks and bonds were both down in the same year. And while we are certainly not in a financial crisis, it might feel like one when you look at your brokerage statement. The truth is that this didn’t happen overnight. It’s really been building since the free money era, after the great financial crisis, which was supercharged by the pandemic. But the good news is that this is not the norm. It’s a 100 -year flood event to use insurance lingo, meaning the probability of it happening in any one year is extremely low. And while you wouldn’t decide whether or not to build a house based on a 100-year flood event, you at least have flood insurance. Our flood insurance is threefold. Number one, invest in strong companies that return capital to shareholders over the long term. Number two, keep ample cash and liquidity on hand to be able to weather any market environment. And number three, to stay invested. Over the long term, investors are compensated for the risk.
I’m Daniel Mannix with Management Group Financial Planning for Your Life and Lifestyle.