The first six months of 2022 brought significant declines in the stock and bond markets. In this article, I’ll share details about the stock/bond market performance in the second quarter of 2022, the context of what caused the market declines, and what to expect from the market in the coming quarters.
The Simple Portfolio invests in world stocks, so we’ll look at the performance of the FTSE All-World Index. The index’s return in the past three months was -15.54%. Since the start of the year, the index’s return was -19.96%.
Below are the cumulative returns of the FTSE All-World Index as of June 30, 2022 (source: Vanguard):
This semester has been the worst start of the year for US stocks in more than half a century.
Technology stocks observed the most significant losses. As of July 4:
- Netflix has a return of -69.88% since the start of the year
- Shopify has a return of -76.96% since the start of the year
- Coinbase has a return of -80.47% since the start of the year
The FTSE All-World Index had returns since the start of the year (-19.96%) that weren’t as bad as the returns of some of these technology stocks. This shows the diversification benefits of investing in indexes with thousands of stocks. You aren’t significantly affected by the terrible performance of a handful of stocks.
The Simple Portfolio invests in investment-grade government bonds, so we’ll look at the performance of the Bloomberg Euro Aggregate: Treasury Index, which tracks eurozone government bonds. The index’s return in the past three months was -7.35%. Since the start of the year, the index’s return was -12.26%.
Below are the cumulative returns of the Bloomberg Euro Aggregate: Treasury Index as of June 30, 2022 (source: Vanguard):
Bond returns haven’t been as bad as stock returns since the start of the year, but these losses are unusually high for bonds. The yield to maturity of the Bloomberg Euro Aggregate: Treasury Index is 1.5%. Yields used to be negative/zero; now, they are significantly higher. The expectation is that future bond returns will be higher than in the past years.
What caused these market declines?
Stocks and bonds returns were poor because the Federal Reserve – US’s Central Bank – started aggressively increasing interest rates to fight high inflation in January. They also stopped their quantitative easing program.
Inflation has been very high in the US and the rest of the world. In June 2022, inflation was 8.6% in the Eurozone. Inflation has been high because of:
- Quantitative easing policies led to an increase in stock and bond prices. Through quantitative easing, central banks injected money into the economy to mitigate the impact of the global financial crisis of 2008.
- Government stimulus packages to mitigate the impact of the COVID-19 pandemic.
- Global supply chain crisis that caused shortages of goods.
- Energy and Food markets disruption due to the Russian invasion of Ukraine caused supply shortages and price increases.
Bond prices are highly dependent on interest rates. Increases in interest rates cause bond prices to fall in response.
Interest rate hikes also cause stock prices to fall because company revenues tend to grow slower or shrink. Company revenues are affected because interest rates increase the cost of money/capital, which in turn causes consumers to spend less and businesses to (re)invest less.
What should we expect going forward?
Central Banks have expressed that fighting inflation is a priority for them. And that they will keep increasing interest rates as a result.
The European Central Bank (ECB) hasn’t increased interest rates yet. They plan to raise interest rates in July and September and stop the quantitative easing program. The primary objective of the ECB is to keep Eurozone inflation at 2% in the medium term. The ECB estimates Eurozone inflation will be 6.8% by the end of 2022, 3.5% by the end of 2023, and 2.1% by the end of 2024.
Historically, we know bond returns suffer in periods with high inflation and interest rate increases. Stock returns are also negatively affected but are more resilient to inflation than bond returns. Therefore, we may see further stock and bond market declines soon.
As I share in my book, Introduction to Investing In Index Funds and ETFs, market declines are scary but common and unavoidable. Moreover, market declines are great for investors in the accumulation phase because they can buy more shares for the same amount of money. This increases their investment returns. Therefore, if you just keep buying, you’ll do well. Naturally, this is easier said than done, as from an emotional perspective, staying invested in bad times is harder than doing so in good times.
During the past ten years, low/negative bond yields led many investors to skip bonds. Government bond yields are much better now than they used to be (1.5% vs. < 0%). And these yields may increase even further with interest rate hikes. It is unclear where yields will stabilize and when they’ll be higher than inflation, though.
Interest rate increases are problematic because they don’t just affect financial markets. They also affect the real economy. Mortgages go up, businesses may struggle and lay off employees, and credit becomes more expensive. I don’t know what will happen, but these measures could cause a recession. You should ensure you have enough margin of safety in your financial life to account for a scenario where things get worse before they get better. You may want to consider:
- setting up an emergency fund
- ensuring you have an asset allocation that works for you
- revisiting all your expenses.
I’ve been working on the 3rd edition of my book, Introduction to Investing In Index Funds and ETFs. I’ve rewritten the book to make it more understandable and actionable. I am also working to make the book available in print and on Amazon. As always, existing purchasers will get these updates for free.
I will share more details about the book soon. Subscribe to my newsletter below to be informed when the new book comes out and keep learning about index investing in Europe.