It has been one for the history books. Just about every financial asset you can imagine was crushed in the first half of the year with the exception of a select group of commodities.
The S&P 500 (a gauge for U.S. equities) was down about 21% in the first half - the worst in over five decades.
Let’s highlight a few individual performances across the market:
- Netflix: -71% YTD (the worst performer in the S&P)
- Coinbase: -81%
- Even megacaps like Meta (-52%), Amazon (-38%), and Apple (-25%) haven’t been spared.
Investment-grade bonds, as measured by the iShares Core U.S. Aggregate Bond ETF, lost 11%, their worst start to a year in history.
The Nasdaq Composite and Russell 2000 also had their worst first halves in history.
Only the energy sector posted gains in the first half on the back of soaring oil prices, but even that has lost its mojo recently. The S&P 500’s energy sector has dropped around 22% in the past three weeks (but still trades around 28% higher than where it was at the beginning of the year).
Slowing growth sent stocks and bonds in emerging markets tumbling, although Chinese equity markets have already begun to recover some of their declines.
Cryptocurrencies came crashing down, burning both individual investors and hedge funds alike. The nearly 60% drawdown in Bitcoin since the end of March was the largest since the third quarter of 2011.
The Ukraine war is affecting Europe more than other regions, with energy concerns becoming increasingly severe. The Stoxx Europe 600 Index had its worst first half performance since 2008.
The UK equity market which has been unloved for years has outperformed most other markets. This is because the FTSE 100 has a higher exposure to value companies in the banking, energy and health sectors.
MSCI’s All-Country World Index has tumbled by 20% since the start of 2022, its worst opening six months to a year since the index was created in 1990.
I wrote briefly about how we got here a couple of weeks ago. As inflation remains persistent in many parts of the world, central banks have had no choice but to respond with aggressively tighter monetary policy, ie. raising interest rates.
The Federal Reserve has raised rates by 1.5% so far this year, the Bank of England by 1.25% and the European Central Bank is set to start a tightening cycle this month. Central banks from Australia to Canada and emerging markets have also tightened. Expectations for more have heightened as well.
What Does History Say?
Bad market performance like what we've seen in the first half of this year is by no means an indication of what’s to come. The S&P 500 lost 21% in the first half of 1970, during a period of high inflation that the current environment has been compared with. It surged 27% during the second half of that year.
We can also look at the historical record going back 72 years, to 1950.
Years with negative 1st half returns since 1950:
A few observations:
- Years with a negative first half tend to have positive second half returns, although these recoveries are small - just 1.5% on average. That leaves the full-year returns deeply in negative territory - down 7% on average.
- Of the 21 years with a negative start, 7 of them recovered fully and posted positive full-year returns. The other 14 only managed a partial recovery and ended in negative territory for the full year. So based on the data, it's twice as likely for a negative start year to end in the red than in the green.
- Since 1950, there were just two years where the 1st half return was a negative -20% or more. 1962 had a 2nd half gain of 11.7%. 1970 had a 2nd half gain of 21.1%.
If we look at the S&P's history of drawdowns of 21% or more in the first half, the second half has rebounded significantly each time:
This should provide some kind of reassurance. However, the sample size is small so we can't really derive any statistically significant conclusions.
We need to consider the environment that we are in right now and can only make educated guesses. Whilst history can provide context, markets are forward-looking. And we are in a unique inflationary period.
So, it's likely that the Federal Reserve will continue to raise rates, which will continue to slow economic growth. Earnings estimates will come down. The unemployment rate will go higher. None of this will be good for the market.
Getting policy just right for a "soft landing" to avoid a recession is what everyone is hoping for. But the Fed has a difficult job and history shows that the Fed has rarely been able to pull it off. The U.S. went into recession four of the last six times the Fed began raising interest rates.
Inflation and inflation expectations are key. Once inflation moderates - which it will at some point - it will be easier for central banks to put more emphasis on growth. In the meantime, there may not be much relief for financial markets. Volatility will likely remain the dominant theme in the short term at least.
Even so, a rebound, when it comes, could be dramatic. Markets tend to perform the best when investors are the gloomiest. And investors are pretty damn gloomy right now.
Some say that we haven't yet seen the worst levels of sentiment, which is worse today than at the depths of the pandemic and is more consistent with what we saw during the financial crisis of 2008-2009. I would remind you that the financial crisis was a lot worse than the crisis today.
I would also note that when markets become more volatile, it's helpful to know that panic isn't an investment strategy. Discipline is.
China Could Provide Some Support
China remains a critical part of the system. It is coming out of a difficult quarter due to the lockdowns here in Shanghai and other cities stemming from the country's (dynamic) zero-Covid policy.
With supply chains disrupted around the world, getting China back on track would be a major contributor to returning the global economy to normal footing. It's early days, but economic data rebounded late in the quarter (after several months of disappointment). It suggests that the growth picture here is improving.
With the lifting of restrictions and increasing policy stimulus, there is an 'expected' strong recovery in the second half of the year which should be beneficial to regional and global economies.
Chinese policy is easing to get its economy back on track and policymakers will of course try do what's necessary to hit their official 5%-5.5% GDP growth target, which didn't look realistic just a month ago. If anyone can pull off an unrealistic target, its China. Although additional policy efforts will be needed. This month's politburo meeting will be important to providing an update on the government's thinking around growth and policy in the coming quarters.
As already mentioned, the Chinese equity markets have already begun to recover. And Chinese stocks are still cheaper than U.S. stocks.
Many investors believe that China is set to outperform. The Financial Times recently reported that investors were getting back into Chinese stocks following the latest Covid bout. BlackRock’s flagship China ETF recorded record inflows in the second quarter, and the investor appetite for Chinese stocks hasn’t cooled yet.
Let's see how lockdowns progress. It certainly isn't the end. BA.5.2.1 will enter China for sure.
Before you run out and sell everything, there is one key fact you must keep in mind:
It's only a bear market.
It's not the end of the world.
Most of us have seen bear markets and recessions before. We’ve always come out of them, eventually.
It is difficult to gauge exactly when the recovery will be. We could possibly still end the year in the red.
But with enough discipline and perhaps adding some foreign exposure (and perhaps some alternatives) to your portfolio, you will be ok in the long run. In the years to come you will be rewarded for process and patience.