Since the beginning of the year, we’ve seen significant market declines, and this quarter is no different. In the third quarter of 2022 (Q3 2022), world stocks had a return of -6.88%, while eurozone government bonds had a return of -5.05%.
The Simple Portfolio invests in world stocks. Therefore, I’ll focus on the FTSE All-World index.
The index’s return in Q3 2022 was -6.88%. This performance is better than the previous quarter’s (-15.54%). Since the start of the year, the index’s return was -25.47%.
Below are the cumulative returns of the FTSE All-World Index as of September 30, 2022 (source: Vanguard):
The Simple Portfolio invests in investment-grade government bonds. Therefore, I’ll analyze the Bloomberg Euro Aggregate: Treasury Index. This index tracks eurozone government bonds.
The index’s return in Q3 2022 was -5.05%. This performance is better than the previous quarter’s (-12.26%). Since the start of the year, the index’s return was -16.69%.
Below are the cumulative returns of the Bloomberg Euro Aggregate: Treasury Index as of September 30, 2022 (source: Vanguard):
Government bond yields have been increasing. The yield to maturity of the Bloomberg Euro Aggregate: Treasury Index is 2.1%. In Q2 2022, the yield to maturity was 1.5%. Therefore, future returns of eurozone government bonds are expected to be higher than this quarter’s performance.
What caused these market declines?
Stocks and bond returns were poor because central banks aggressively increased interest rates to fight high inflation. In September 2022, inflation was 10% in the Eurozone! High inflation in the Eurozone has been primarily driven by high energy and food prices.
In September, the European Central Bank increased interest rates by a record margin, 75 basis points. The Federal Reserve – US Central Bank – also raised interest rates by 75 basis points in September.
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 can we expect going forward?
Central Banks have stated that they will keep increasing interest rates to reduce inflation. So, we can expect stock and bond market declines when that happens. We can’t predict when those declines will happen and their severity, though.
Not a lot has changed since the last quarterly market review, so I’ll leave you with the same parting words:
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.
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 also wanted to tell you a bit about the 3rd edition of my book. I can’t wait to share the updated book with you.
I’ll publish the book in November (next month!). As always, existing purchasers will get these updates for free.
I’ll be sharing more about the improvements to the book in the coming weeks. Subscribe to my newsletter below to be the first to know about the book and index investing in Europe.