2022 has been a terrible year for financial markets. The Fed has been forced to raise interest rates to combat the highest levels of inflation we have experienced in 40 years. The double whammy of inflation and higher interest rates have driven up the cost of doing business, subsequently squeezing profits and investor returns. 

Domestic and international stock markets are all down over 15% this year. Bonds are down double digits as well. This is the first time in over 30 years that both stocks and bonds are down in the same year. 

But there is good news!  

First, even with the dramatic losses we have experienced this year, the majority of portfolios are still higher than they were three years ago. 

Second, higher interest rates mean bond holders will receive more income on their bonds going forward.  

Third, drops in equity markets have brought equities back to more traditional valuation ranges as measured by the Price to Earnings ratio (stock price divided by earning per share). 

History suggests that the lower the Price to Earnings ratio, the higher market returns will be for investors over the following 10 years. The chart below shows P/E ratios on the X axis, with more expensive starting points (i.e. higher PE ratios) to the right. The Y axis shows the subsequent returns.

Putting higher bond returns and higher equity returns together; we think investors may be able to take a little less risk going forward. That is, a portfolio with a somewhat higher allocation to bonds may produce a return that meets a given investor’s needs without as much volatility.  

We may still have some pain to endure in this market cycle, but we think we are in a better place for the long run. So, feel free to complain about the markets over your turkey dinner AND be grateful for the opportunities the markets seem to be presenting. Happy Thanksgiving!