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What Retirees Can Learn From 2022’s Miserable Markets

Bear markets aren’t unusual or surprising

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Good riddance to 2022, at least from a financial perspective. Measured by the returns from low-cost index funds, the U.S. stock market lost 19.5 percent, while investment-grade bonds tumbled 13.2 percent. Inflation surged, running at an annual pace of 7.1 percent for the 12-month period that ended November.    

Before I get to surprises and lessons, let me first dispel a couple of myths about surprises that weren’t.

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First, the loss in stocks for the year is no surprise. Bear markets are part of investing, so the loss for the year is not out of the ordinary. Also not a surprise was the fact that market forecasters were way off. Forecasters called for a small gain in the S&P 500, and it actually lost 19.4 percent. This is not out of the ordinary either: No one does a very good job of predicting market returns. Finally, the fact that stocks declined at the same time as bonds isn’t a shocker: Statistically speaking, the correlation between stocks and bonds is close to zero, meaning that nearly half of the time they move in the same direction.

The three biggest surprises

1. While both stocks and bonds declining wasn’t a surprise, the magnitude of the losses in bonds was. 

High-quality bonds act as the shock absorber for your overall portfolio, but bonds lost nearly as much as stocks, even when you count reinvested interest. Using a traditional statistical measure called standard deviation, the loss for the first three quarters of the year should happen about once every 50 million years, according to Edward F. McQuarrie, professor emeritus at the Leavey School of Business at Santa Clara University. While I don’t have the data for the full year, bonds didn’t recover much in the fourth quarter. 

Thus the first lesson for surprise number one is that we don’t live in a world of normalized distributions (think of the bell-shaped curve). We live in a far more unpredictable world where extreme events happen on a semi-regular basis. 

The next lesson is that bonds still have less risk in a year than stocks have in a day. Though the 13.2 percent loss in bonds for the year is an extremely unusual event, it is less than the 20.5 percent suffered by the Standard and Poor’s 500 stock index on Black Monday, Oct. 19, 1987.

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The third lesson is that losses in bonds can be a good thing. Bonds lose value for two reasons: The issuer is in financial distress and may default on its payments, or interest rates surge. The former wasn’t the case in 2022, but rather the latter. Bonds lost value because interest rates surged. I explain why this happens in bond basics, but it’s essentially because people now want a higher interest rate return on their bonds, making existing bonds and bond funds with lower yields less valuable. That’s what happened in 2022.

So the good part of this is that we can now earn far more on our bonds. Investment-grade bonds yielded 1.51 percent going into the year but closed the year yielding 3.88 percent. Today, you can buy a five-year bond known as the Treasury’s inflation-protected security (TIPS) that is guaranteed to beat inflation by 1.66 percent annually, whereas last year it was guaranteed to underperform inflation by 1.61 percent annually. TIPS are now even better than I bonds. 

2. The second surprise is that international stocks fared better than U.S. stocks. 

International stocks lost 16 percent but bested U.S. stocks by 3.5 percent for 2022, and by a whopping 7.5 percentage points over the last quarter, surging 14.7 percent, all while the rest of the world was dealing with the economic aftermath of COVID and Putin’s invasion of Ukraine, a conflict that now seems likely to continue for some time. This has had a huge impact on other countries, especially in Europe. China seems to be more at odds with the West, and increasing worries about its invading Taiwan don’t help. Overall, the U.S. dollar gained 7.9 percent against world currencies, yet international stocks fared better than the U.S. Typically, foreign stocks do better for U.S. investors when the dollar is weak.

The lesson for surprise number two is that markets baffle us. Even hindsight can’t always explain the past. In other words, you were not crazy to own international stocks.

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3. The third surprise is that the price of oil and gasoline increased less than inflation. 

The price of crude oil was $75.21 the last day of December 2021 and ended 2022 at $80.26, only a 7 percent increase, slightly less than inflation. In fact, as of Jan. 5, oil is even cheaper than it was at the end of 2021. The price of gasoline actually decreased from $3.41 a gallon in December 2021 to $3.32 in December 2022. In fact, gasoline costs a bit less than it did a decade earlier.

All of this happened during the Russian oil supply shock of 2022. On top of that, recently the Organization of the Petroleum Exporting Countries (OPEC) announced it was cutting supply. Oil peaked at $123.70 on March 8, shortly after the Ukraine invasion, and then declined 35.1 percent from that high by the end of the year. Though one could argue the U.S. release of oil reserves was partially the cause, oil is a global market and the U.S. has announced it will soon be buying oil to replenish reserves.

The lesson for surprise number three is that not only are all financial markets unpredictable, but they are also unpredictable even in the face of what seemed obvious at the time. In this instance, it seemed obvious that if the war persisted and OPEC didn’t step in to fill the void, oil and gasoline prices would continue to surge. Some predicted $10-a-gallon gasoline.  

Summing things up

We want to feel like we are in control of our financial future, and it’s only natural to think we can predict markets to at least some degree. Accepting that we don’t know can be very scary. Accepting that there will be more extreme surprises going forward is even scarier. Still, it’s one of the keys to good investing and financial decision-making in general. 

2023 will bring more surprises. Don’t assume it will look like 2022. While I don’t know the future, I do know that both stocks and bonds are better values today than they were going into 2022. I know that low-cost diversified investing for the long run has a better shot of helping you reach financial independence sooner than either making big bets on the future or leaving everything in cash.

Here’s hoping the 2023 surprises are more pleasant than those of last year.  

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