Welcome to our July 2022 Newsletter

Research suggests that when faced with receiving mixed information, most people prefer to hear the bad news first.  With that in mind, here is some of the bad news that has affected the capital markets:

• Inflation is currently at a 40-year high, with the 12 month trailing CPI registering over 8%.
• The stock market’s 1^st half return of -20% is the worst in over 50 years.
• The bond market’s -10.4% return is the worst 1^st half return in modern history.
• Supply chain issues and labor market shortages persist.
• In addition to the catastrophic humanitarian impact, the war in Ukraine has also caused significant economic disruptions.
• Political turmoil is high, with an historically unpopular administration and several very controversial Supreme Court decisions.

Fortunately, there is also some good news to help offset what has been a very challenging time for many:

• The worst of the Covid pandemic appears to be behind us, with the vast majority of Americans now vaccinated and severe Covid-related hospitalizations and deaths well below longer-term trends.
• The overall U.S. economy is sound.
• The job market is very robust, which offers choice and upward mobility to an unprecedented number of workers.
• Despite the substantial year-to-date declines in both stock and bond markets, the longer-term returns (i.e. 3,5, 10 year) are close to their historical averages.

This last point bears repeating

Even with the poor markets we’ve experienced YTD, most portfolios are at or above where we would have projected them to be 3-5 years ago.  While psychologically it’s not ideal to experience returns well above the historical average only to see a marked decline bring them back in line with that average, that is exactly what has happened – particularly when it comes to stocks. 

Below are the trailing 1, 3, 5 and 10 year annualized % returns for the S&P 500 and the Barclays U.S. Aggregate Bond Index as of the end of 2021 and the first half of 2022:

As one can see, despite the stock market being down about 20% this year, the annual returns for 3, 5 and 10 years are all above the 10% threshold that investors seek to achieve when investing in the stock market.  Bonds are not quite above their long-term averages due mainly to the nature of this particular crisis – namely a large increase in inflation.  Inflation is the #1 enemy of fixed income securities because while the yield of most of these instruments is just that – fixed, the prices of the goods and services that investors seek to buy with bond income have gotten a lot more expensive.  This dynamic has been particularly challenging for investors, as bond prices usually increase during times of crisis, which helps offset the decline in stocks.  That’s not been the case this time.  All in all, however, investors of a mixed portfolio of stocks and bonds still have done well over the long-term due to the excess returns provided by stocks for over a decade now.

Granted, it would be preferable for all investors (and investment advisors) to be able to invest in securities that returned their historical averages each and every year.  That would make it much easier to time things like capital contributions and withdrawals, retirement dates, etc. as well as being much less stressful for all involved in general.  Unfortunately, that has never been the case when it comes to the capital markets and will likely never be in our lifetimes.  ‘Stable’ investments that do not fluctuate have returned much less than the inflation rate for over a decade, and continue to ensure a loss of purchasing power over time.  Instruments like money market accounts and CD’s are excellent vehicles for emergency savings and short-term liquidity needs, but unfortunately they have not increased wealth in real, inflation-adjusted terms. 

While it can be instructive to look at what has transpired and how we arrived at this point, it also natural to try to anticipate what the future may hold.  On this front it is important to remember that the stock market is a leading indicator.  Its value today represents what investors think about the future.  It’s tempting to see potential difficulties ahead – continued high inflation, a Fed-induced recession, etc.  – and expect weak market returns as a result.  History suggests, however, that stock prices recover well before real-time economic data and sentiment improve and that the largest gains are often in the first few weeks of recovery.

It is precisely at times like this when we must remind ourselves of what has worked in the past and what is likely to be a good strategy going forward.  To anyone who has been with us for a while (we are truly blessed at BFM to have worked with a majority of you for a very long time), the answer will not be surprising.  Most, if not all, of you have heard the very same keys to success in all of our communications from our initial informational ‘kick the tires’ meeting to our regular investment reviews.  Namely, the good news is that what we have all been doing in the past which has led to meeting or exceeding your financial goals is likely to still be the best course of action going forward.  Our formula for investment success remains the same:

1. Identify your investment goals and risk tolerance – while often similar, no two investors are identical.
2. Craft a portfolio structured to meet these goals using the time-honored principles of diversification, a sound investment philosophy and periodic re-balancing.
3. Do not let the highs and lows of the markets cause you to make emotionally driven decisions that run counter to your long-term plan.
4. Meet with your investment advisor regularly to review your progress towards your goals and to share any changes in your situation that might affect your plan.
5. Lastly (with perhaps just a touch of tongue-in-cheek), listen to more music radio and less talk radio (or cable news or internet click-bait).  Media is an enterprise that exists primarily to capture attention.  No one ever sold more advertising by proclaiming “This is one of many crises that you will likely endure in your lifetime as an investor, but the best course of action is to not panic and take no action!”.

These are trying times for sure, but we’ve been through many trying times together. To borrow a phrase that President Lincoln famously uttered – “This too, shall pass.”  As always, we sincerely value and appreciate the trust you have placed in us.  Please reach out to us if you have any questions or concerns or if you would like to schedule a meeting with your advisor.

One last informational note

Many of you have inquired about I Bonds.  I Bonds are long-term (30 year) U.S. government bonds whose interest rate is pegged to the trailing inflation rate.  This rate changes every 6 months.  For most of the past decade that rate has been very low (in the 1-3% range), but because inflation has really shot up this past year, the current 6-month yield is 9.6%. 

The Advantages of I bonds are:

1. They currently pay a very attractive rate. 
2. They are backed by the U.S. Government. 
3. They have a fairly flexible term.  You can redeem an I bond after a year, but if you do so before 5 years, you lose 3 month’s interest.

The Disadvantages of I bonds are:

1. They cannot be held in existing brokerage accounts and must be purchased directly from the U.S. Treasury.
2. You can only invest up to $10,000 per person, per year. 
3. The yield is pegged to the inflation rate, so while you are preserving your purchasing power (i.e. your investment is going up the same amount as the average increase in the cost of goods and services), you are not growing your wealth in real (i.e. inflation-adjusted terms). 

More information can be found on this page at the US TreasuryDirect webpage.

Thank you for reading our Newsletter!

Sincerely,

All of us at Broadlake Financial Management

Matthew Malaney, Joe Diebold, Andrew Murphy, & Joseph Smithwick