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May 2022 highlights

Opening: This is Mark Peterson with the May 2022 Student of the Market.

(00:06) Slide 3: Worst ever start to a year for bonds

Obviously continued volatility in the market historically terrible start for bond for the year.  Lots to talk about.  We'll begin on slide 3 looking at that terrible start for bonds for the year.  It is the worst start ever.  It probably feels that was and it certainly is down 9 1/2 percent for the core bond index through the end of April to start the year.  That is without a doubt by far the worst start for bonds going back to 1926.  You can see the second worst start to the year was 1994, which was down 3.6 percent.  So, we're well beyond that today.  Of course, '94 ended up being being the worst bond year in history.  We were down a little bit less than 3 percent.  So, you can see '94 you did get a little back towards the end of the year.  And certainly, we'll probably challenge 1994 for the worst year in bond history, this year.  But you can see some of the other worst starts to the calendar year.  You do have periods like 2021, last year is on here, 2018 as well.  Clearly a result of a low interest rate world.  You just lose a lot of that income, a lot of that cushion that bonds provide, obviously you're going to have more negative bond returns.  So clearly we're in a better place today.  If you've got closer to 3 percent on a 10-year U.S. Treasury bond, that's a lot more income than we were receiving.  You think back to the end of 2020, we were less than 1 percent on that 10-year Treasury bond.  So clearly a better starting point going forward.  A lot more income.  A lot more cushion to build into portfolios.  But still clearly a terrible start.  Interesting looking at some of these other periods where we, where we were off to a slow start for bonds.  You can see next eight months, next 12 months, bonds were higher.  Granted, in some of these periods rates were a lot higher in the '70s, '80s even into the '90s, interests were much higher.  So, you could have just collected income the rest of the year and had a positive return.  But clearly some of these periods also had a price return that was positive as well as interests settled in, found their footing.  Clearly a combination of those two led to some pretty good returns 8 and 12 months later after such a slow start to begin the year in fixed income.

 

(02:26) Slide 4: U.S. bonds: Percent of periods that earned a positive return

Beyond just that first four months of year, of course, we're moving out into longer term time periods now bond returns really are truly historic in the amount that they're down.  You look on the right side of slide 4, the one-year period, we down 8 1/2 percent for that core bond index over the last one-year period.  That's the second worst one year window in history, again going back to 1926.  More than 1,140 different rolling one-year windows of time.  This is the second worst return ever for bonds in history.  Truly historic.  Only March of 1980 was worse when we were down 9.2 percent.  And you can see some other periods like the three-year average annual period of time is only a positive 40 basis points right now.  So that's a number that might turn negative.  And it's pretty rare to see that three-year number negative for bonds.  You can see that again going back to 1926, 99 percent of three-year windows have been positive.  So only one percent of those windows historically has been negative when you look at a three-year period of time.  We'll probably challenge that.  It'll be interesting to see over the next couple of months as we roll off some good months for bonds depending on what we roll on that three number might turn negative, which is historically rare.  It has happened but not very often.  When you move out to a four-year period of time, that's when bonds have been positive 100 percent of the time.  No one's ever lost money in this core bond index going back to 1926, if they held it for four years.  And we're still a positive 1.6 percent average annual return over that four-year stretch.  So, we're pretty safe at this point historically.  It's actually, we actually had lower four-year periods of time as recently as November of 2018.  We had a 1.2 percent four-year window of time for the core bond index.  So, I thought this chart was good to really paint the picture on the rarified era that we're stepping into with bond returns.  Moving out beyond just last year or the first four months of this year, you're really starting to see those negative returns show up in the one-year number especially and even potentially the three-year number at some point.

 

(04:59) Slide 5: Returns following bad periods for bonds

And to build on that, I think it's important, we can talk about what's happened in the rearview mirror. Let's think about where bond are headed, what does history tell us.  I think to do this properly we really need to strip out that income component and just look at the big price moves for bonds historically.  You can see that the last -- or excuse me, the price move that we've seen over the last year for bonds is down about 10.4 percent, which is not the worse, not second worse.  You really have to go down the list to find it, right in the middle, if you look at the top 25 worst price moves for that bond index.  Historically again that excludes income.  I think that that really, really helps you understand the fact that a portion of this loss that we're seeing is because we came off such a low interest rate environment.  We were less than 1 percent on that 10-year U.S. Treasury at the end of 2020.  So, coming off low interest rates, you just don't receive the amount of income that you do in a higher interest rate world.  So clearly that's one of the drivers here.  But I wanted to see if we strip out that income, what does the price return look like one year later?  And you can see it actually looks pretty good for these top 25 biggest moves in price only for bonds historically.  You can see on average one year later, you actually rebound a little bit.  On average you're up about 4 percent for that bond return.  So, if you include a 2 or 3 percent income stream that would put you into a total return range of 6 to 7 percent.  A little bit different than what the average is historically because again some of these periods in the '80s especially you had much higher interest rates, much bigger income that you're receiving.  Remember that's when we had double-digit interest rates, double-digit inflation.  So clearly we don't have the benefit today of that much higher interest rate level that we saw in the '80s.  That's why it's so important to really strip it down to this price only component to really understand how much did the, did interest rates and price movement rebound following these big move higher interest rates what we've seen.  And generally, they do settle back on average of about 4 percent price gain over the next 12 months.  Not positive in each one of these periods but I think we'd all take 4 percent right now in bonds, plus a little bit of income on top of that looks pretty good.  And at least that's, that's what history has told us.

 

(07:39) Slide 6: The Fed raising rates by ½ percent or more

Of course, one of the stories is going to be the Fed raising interest rates this month.  Certainly, expect them to raise interest rates by 50 basis points in the month of May and certainly at some point in the future it seems very likely at least the market's priced in.  I didn't want to take a deep dive here but just did want to pull out the last time they raised by more than 1/4 percent.  Look at that 1/2 percent move or more and what the market did, I don't think there's too much to tell.  Really not enough periods to really, to really take much away here.  I think each one of these periods tends to be very unique and different.  You can see following '94, '95, clearly the Fed moves too fast.  And you can see the bonds and stocks had pretty good periods following, especially one year following that '94, '95 period.  And of course, 2000, they were a little late to that ballgame, that tech bubble that had inflated.  They were still raising rates into 2000, 50 basis points trying to really tame some of the economic growth and some of the momentum the tech bubble had created but clearly that was just really almost the end of that cycle where that bubble started to burst for those technology stocks and led us into a recession into 2001.

 

(09:02) Slide 7: 3rd worst start to a year for stocks

Looking at stocks for the year, of course stocks off to a slow start as well.  We're focused so much on bonds.  But stocks down almost 13 percent, 12.9 percent for the first four months of the year.  That's actually the third worst start for stocks.  I was a little surprised by that.  I thought some other periods might have eclipsed that.  But only 1932, 1939 were worse.  And again, a similar story to bonds.  If you look at how they finish off the rest of the year, how they looked 12 months later, it actually looks pretty good on average.  Not every period, you have periods like 1973 or 1941 clearly where stocks continued to head lower but on average you're up 14 percent for the rest of the year, up 24 percent 12 months later.  It paints a pretty rosy picture I think really.  You think about 1941, that we're in the middle of World War II.  1973, that was certainly a big bear market and recession back then.  I think this really helps paint the story that if we don't get a recession and you don't get a bigger geopolitical event the chances that stocks rebound looks pretty good based on the historical data.

 

(10:14) Slide 8: Volatility picking up in 2022

And of course, volatility's picked up, had a lot of folks who wanted us to update this slide.  Just looking at the number of 2 percent trading days in the S&P 500 this year, we've had 12, six positive and six negative days, so 2 percent days tend to be those that are pretty visible for folks.  You can notice a 2 percent move and it tends to grab headlines in the media.  So, we've had 12 so far this year through the end of April.  That's more than we had all of last year or more than we had all of 2019.  It puts us on a pace for about 36, which isn't as much as we had in 2020, but starts to get into that pretty volatile period.  You can see we've had some other periods that volatility was much higher, 72, back in 2008.  If there's 252 trading days in a year, if you have 72 of those days that are 2 percent moves that's pretty volatility.  That's one every three or four days you're going to get a 2 percent move.  Clearly not on that type of pace but half of that right is still up there from a volatility standpoint and certainly it's felt that way.  And you look at these periods and I always make this point that whenever we see periods of market volatility it's always the market trying to digest where we're headed in the economy.  And I think that's going to continue to be a struggle.  Even though we feel like we're on pretty good economic footing, clearly all the challenges that we're faced with here in 2022, right, the Federal Reserve rate using short-term interest rates, geopolitical concerns with Russia and Ukraine.  Just the uncertainty still restarting the economy post-COVID, supply chains, inflation, all those issues I think are going to continue to drive that uncertainty here in 2022 for the economy.  And that's going to drive volatility, continued volatility with the markets as well.  So, we'll keep an eye on this one and keep it updated.  I think clearly going to be a challenge here for the rest of the year.

 

(12:18) Slide 9: Stocks and bonds entering a new seasonal return period

And of course, this time of year, moving into May we have to dust off our seasonal story with stocks and bonds, what we call mommies to mummies is the period that we're entering.  So of course, May is the month of Mother's Day and then October 31st is Halloween, or mummies.  So, mommies to mummies is a six-month period of time where actually stocks have historically their worst return.  Since 1926 they only return about 4.4 percent in this mommy to mummies period versus 7.4 percent for the best six-month window, which we lovingly call turkey to tax, November 1st to the end of April.  So, we're moving into a slower period historically.  Obviously 4.4 percent is still pretty darn good returns.  I always hate that phrase, sell in May and go away, that market adage that's out there because still 4.4 percent, not too shabby historically for fixed income.  You can see the last 40 years, this difference has actually grown a little bit for stocks as well where you see 4 percent returns in the mommies to mummies period, but 8.7 percent for turkey to tax.  So, it's actually grown in the amount of seasonality that we've seen for stocks.  Interestingly enough on the bond side, it's the opposite.  You can see that historically bonds do a little bit better in that mommies to mummies period, especially over the last 40 years.  Look at the difference in the last 40 years.  You get 4.4 percent for bonds in this mommy to mummies, May 1st to October 31st stretch.  And only 2.7 percent for bonds in that turkey to tax window.  So, I thought that was just interesting.  Probably makes sense, right, if stock do better in one part of the year than another, bonds will do better in the opposite period which is the period that we're stepping into now.  So maybe some other good news that you can bring back to your bonds folks that generally we're stepping into a seasonal period where bonds do a little bit better than the last six months that we just, six months that we've just gone through.

 

(14:30) Slide 10: Inflation-adjusted returns are starting to look like the ‘40s and ‘50s

And finally, I always like to talk to inflation.  Inflation continues to be a challenge.  I wanted to just bring out the historical map on what stock and bonds and cash have done on a, on an inflation adjusted return basis just by decade.  I think it paints an interesting picture when you look at these various time periods when, especially bonds and cash have been really challenged.  It really starts to look more like the '40s and '50s coming out of that Great Depression, World War II era bond returns, interest rates were really low, certainly the interest rate on cash was tough to find.  And you can see how deep the negative returns were in the '40s especially for bonds and cash.  You're talking about for the decade, and these are cumulative returns, so these are not average annual.  You can see 29 percent loss, 38 percent loss for cash, 29 percent for bonds.  Truly historic.  And if you look at the 2020s so far, so just two and a half years, or not quite two and a half years into this decade, you can see we're already down 13 percent on an inflation adjusted basis for bonds, down 9.6 percent for cash on an inflation adjusted basis.  Again, those cumulative, not average annual numbers.  But I think really it starts to paint that picture.  I think everybody likes to think of the '70s and '80s being similar from an inflation standpoint and certainly that's the last time we saw such an extended period of time where we had higher inflation.  But when you start adding back asset class returns the '70s and '80s were very different just because we had so much higher interest rates, so much higher cash rates as well.  You saw that into the '70s and the '80s as well.  Just set up a better return environment for bonds and cash especially versus today.  Today looks much more like the '40s and '50s where you have, you're coming off such low interest rates.  Certainly, higher interest rates put pressure on bond returns and then you add a period of higher inflation on top of that, you really start to get to deeper negative returns for fixed income.  So, I thought that was just interesting to look at the inflation adjusted returns by decade, really looking at the comparison.  1940s and 1950s actually looks more similar to today than that '70s and '80s period.

 

Closing

That'll do us, do it for us for the May 2022 Student to Market update.  As always if you have thoughts or comments on content, certainly we'll, we'd love to address that in the future.  You can reach out on our website, the Student of the Market BlackRock.  There's a comment piece there.  We encourage that feedback and again, thanks again for listening to BlackRock's Student of the Market.

Worst ever start to a year for bonds

Core bonds returned roughly -9.5% in 2022 through the end of April, marking the start to this year as the worst ever on record.

The Fed raising interest rates by ½ percent+

When the Fed has raised rates by ½%+ in the past, stocks and bonds typically continued to post relatively strong returns over the following 6- and 12-month periods.

Inflation-adjusted returns

Comparisons have been made between the inflation now and the inflation we saw in the’70s and ‘80s, but our current experience is more like the ‘40s and ‘50s when looked at from a return perspective.

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