2022 Investment Markets in Perspective[1]
For many investors, 2022 is a year they would like to forget. 2022 was one of the worst years overall for investors in history. While stock returns have always been volatile, bonds have typically been a safe refuge when stocks do poorly. 2022 however, was a devasting year for bonds. While the stock market has had worst years, this is the worst year for bonds since reliable data has been available (about 100 years). With high inflation, tightening monetary conditions, and rising interest rates, the overall bond market was down about 13%. Paired with an 18% decline in the S&P500, a typical retirement portfolio was down about 16%. In today’s blog, we will drill down into the returns for various investments in 2022, look at a longer-term perspective and address potential future returns.
2022 Returns by Investment Type
To look at returns for different types of investments, I prefer to look at returns from ETFs representing each type. ETFs provide the best measure of total return, including gains/losses, dividends, and expenses. Most investors associate overall market performance with market indices such as the S&P500 and NASDAQ 100. ETFs investing in these indices shown in the first two rows of the table above were down 18% and 33%, respectively. These indices are market cap weighted, meaning that they invest more heavily in stocks with the largest stock market capitalization (stock price times shares outstanding). As a result, they are biased toward large companies with a high level of past growth and relatively high prices relative to fundamentals (e.g., earnings). The QQQ ETF following the NASDAQ is heavily skewed towards technology companies. These companies were hit particularly hard in 2022.
If we look at the performance of VTV, an ETF composed of so-called value stocks (stocks selling at low prices relative to fundamentals), we see that performance was substantially better than the large market-cap-weighted indices. VTV was down only about 2% for 2022. This index is also market-cap weighted; however, not skewed toward growth or technology. Another type of index/ETF weights stock holdings by fundamentals (earnings, assets, etc., versus market price). The FNDX is one such ETF. This provides more of a blend of value and growth (growth at a reasonable price). This ETF was down about 7% for 2022.
Looking internationally, the FNDF ETF, a fundamental-weighted international ETF, was also down about 8%. Current economic and market conditions are similar around the world. There has been no refuge in 2022 from stock losses.
Smaller company stocks (mid-cap VOE and small-cap VBR) were down as well – about 8 or 9% on a market cap basis.
VNQ representing real estate was down significantly at 26%.
Turning to the bond markets, they were down as well. The overall bond market, including short-term, intermediate-term, and long-term (ETF BND) was down 13%. Looking at intermediate U.S. government bonds, a popular investment category, they were down about 10.5%. Short-term U.S. bonds and inflation-protected U.S. bonds were down 4% and 3%, respectively.
Astute investors know the benefits of diversification. In most years, all investments do not move in the same direction. 2022 was a major exception, with most moving in the same direction. Bonds typically soften the impact of stock market losses. Not in 2022. As a result, a typical retirement portfolio invested in 60% stock and 40% bonds was down 16% – highly unusual. The only safe refuge was in commodities. The DBC ETF, a diversified commodity ETF, was up about 19%. As a result, stock and bond losses were somewhat moderated if your portfolio included commodities. Most investors, however, do not make significant allocations to commodities as their long-term performance has not been great (more on this in the next section).
The Longer-Term Perspective
If we take a longer term perspective returns have been strong for most investment types in spite of 2022 performance. Looking at 5 year returns (including 2022) all of the investment types had positive returns. Large company stocks were up about 9% per year on average, just slightly below the 10% average over the last century. Small and mid-cap stocks were up 5-6% on average, although this is lower than historic returns for these investments of over 10% per year. International stocks and real estate investments trust returns for the 5 year period are modest at 2 to 4%. Bonds were largely flat for the five years with returns of less than 1% a year. Returns over the last decade (again including the losses in 2022) were strong for all stock types with returns over 10% per year. Bonds were still marginally profitable and commodies were the only group with a negative average return over the past decade.
So if you have been invested for the long term you have still done well in spite of 2022. If you are a new investor you may have lost money in 2022 but if you are still adding to your retirement accounts you are buying at lower prices and this bodes well for your future returns.
Looking at how diversified porfolios performed over the long term. A porfolio of 60% stocks and 40% bonds earned about 6% over the last 10 years. If we look at the prior 20 years for typical diversified porfolios, they were only down in three of those years as shown in the figure below. 2008 was the worst year in those two decades for a diversified (or undiversified portfolio). While the bond market was up about 5%, the stock market was down 37% in 2008. A 60/40 portfolio would have been down 20%. 2022 would be the second worst in two decades at a loss of 16% for a 60/40 portfolio.
Looking to the Future
Returns from the stock market for the next decade and longer are not likely to be as high has historic returns. The long term average of 10% is not likely to be achieved. Even though the market was down in the last year, the overall market is still valued richly relative to the past – price -earnings ratios are still higher than they have been historically. Looking at the current level of the stock market, future long term annual returns are more likely to average 7 to 8%. There will continue to be a high degree of variability though, with some years negative and some years better than the average. Given the possibility of further interest rate increases, continuing inflation and a recession in the short term it would be advisable to remain defensive and biased towards value or growth at a reasonable price oriented stock investments. These typically do better in a recession and subsequent recovery.
Bond returns are more promising going forward relative to their recent performance. You can now buy short term treasury bills yielding 4% or more. Given current pricing of bonds overall long term returns of 3.5% to 4% are likely across various maturities. In the current environment it is best to be biased to shorter term bonds and moving to longer term bonds as rates improve.
What does this mean for a typical investor? It depends on your time horizon and risk tolerance. A typical retiree has 60 to 70% in stocks and 30 to 40% in bonds so a typical retirement portfolio given the above mentioned returns should expect an average return over the long term of about 5.5% to 6.5%.
As always it pays to be diversified. Do not put all of your eggs in one basket (investment type). Your overall asset allocation should be set up to enable you to sleep at night and not make rash decisions to sell during market volatility.
[1] Please note that past performance may not be indicative of future results.