U.S. markets experienced a historic reckoning in 2022 after the Federal Reserve's efforts to combat the worst inflation in decades sent stocks and bonds reeling. The combined total return for both stocks and bonds was the worst of any year dating back to 1872, according to a market analysis by Deutsche Bank research head Jim Reid, who labeled 2022 "the biggest outlier year in history."
Bank of America Equity and Quantitative Strategist Savita Subramanian also noted that 2022 was the worst year on record for 30-year bonds, which were down 33%. As both stocks and bonds fell, most retirement accounts shrunk in value during 2022.
The long-heralded investment portfolio mix of 60% stocks and 40% bonds combined, on average, to drop 24% during 2022, the worst return for this type of portfolio since 1930. The market value of Chattanooga's publicly traded companies plunged by nearly $3.8 billion last year.
The good news for investors is that 2023 should do much better, especially later in the year. Historically, the rare years where both stocks and bonds declined have been a sharp rebound in the next year, according to an analysis by the Leuthold Group.
Edge magazine talked with a Chattanooga financial advisor, a finance professor at the University of Tennessee at Chattanooga, and local resident on the verge of retirement to see what they expect for investments in the year ahead.
Stefanie Crowe MBA, a certfiied financial planner (CFP), is a veteran banker, entrepreneur and angel investor. Along with founding AegleWealth in 2020, she is a co-founder and general partner with The JumpFund, an angel fund supporting female-led ventures in the southeast formed in 2014. Crowe spent more than a decade with Bank of America/US Trust advising families with wealth-building strategies to include trust and estate management, investments, private banking and charitable planning.
Q. How should investors adjust their portfolios in response to higher interest rates? What are you suggesting to customers?
A. My approach is always to look at investments through a planning lens. When talking about higher interest rates, I want to be sure the cash that clients have is working for them in a higher-yielding savings account. Rising rates affect credit card rates.
So if anybody is carrying balances month to month, those payments are going up and we've got to address that as a priority while also saving for retirement. I don't exclusively talk about investments if clients don't have enough cash on hand or if their credit card balances are heavy, because those things will hurt an investment plan.
The next thing I look at is the bond positions. Investors will start earning better interest rates on bond holdings. Some bond holders in a low-rate environment started buying lower-quality bonds as they stretched for more yield. In a recessionary environment, you don't want low-quality bonds. The quality of the bond portfolio is important.
In looking at equity positions, in a rising rate environment growth and innovation stocks are penalized. The value investor -- someone investing for dividends and current cash flow -- is rewarded.
It's important for people to remember that inflation has a big impact on and will hurt your purchasing power. Since people are living so long in retirement, the loss of purchasing power is something you want to manage by allocating to both stocks and bonds. Don't let market shifts disrupt your plan or strategy. It really has everything to do with a person's time horizon.
Q. If the economy continues to slow, how will that affect the stock market?
A. There are many facets to the market. In a global recessionary environment, the U.S. will be the safe-haven and emerging markets will experience extended weakness. There's a spectrum of investments between those two. It's about creating a blended portfolio that's appropriate for the client.
Dividend-paying stocks will show more resilience. Large company stocks tend to do better than small company stocks during a recession. Big companies have a bigger balance sheet -- reserves, access to credit, diverse revenue streams. They have more survivability. Small companies are deemed more vulnerable during a recession.
Another point I bring up to clients who are afraid of the "R word" is that people can overreact to the word "recession" when they hear it every day in the media. It's important to remember that the market is forward-looking, so the pricing we see today is reflective of where we think the economy will be in nine months.
Q. We saw steadily rising stocks for more than a decade until the pandemic created a more volatile market over the past couple of years. Do you expect the volatility to continue? How do you tell customers to respond when the market is up and down?
A. I remind clients that we've benefited from an extended period of quantitative easing and low-interest rates coming out of the Great Recession. It's been unusual. We've been in stimulus mode for a very long time. But asking if we'll have continued volatility is like asking if we'll have negative surprises. There are always negative surprises.
I always acknowledge the feelings around volatility, like the nausea it creates. But I like to review charts on how the market has moved over the decades over serious events -- including the dot-com bubble burst, Y2K and the attack on Trade Towers. History shows that we're not going to avoid negative events. They're coming. But we can manage through them and that's why you have a strategy. You don't want a crisis to make you throw out a good plan. That's why having an advisor helps -- having a person with a different perspective who can remind you of the plan, so when adverse situations arise, you can be more proactive and less reactive.
I also remind people who are in saving mode that volatility brings prices down, so that when you're dollar-cost averaging, it's like buying on discount. It doesn't feel good to see valuations decline, but you're buying at better values over time. I made some of my best money during a financial crisis. I made investments while most assets were down significantly. It was painful; and I don't want to minimize the damage the crisis did. But for consistent savers and investors -- embrace volatility. If you're in accumulation mode, volatility is your friend.
And I will add that, another factor to remember with volatility is, don't buy garbage. Developing the ability to differentiate between investing and speculation pays off with volatility. Today we're seeing some of this related to crypto. People made these investments, but there's a lot of speculation. Volatility exposes the garbage in the market. If an investor is buying quality, hopefully they'll have a more resilient experience than those who are speculating. I caution clients not to bail out of a good, quality, long-term investments, because that's the behavior of a speculator and not an investor.
Q. What sectors of the economy or investment options do you see the most opportunity in for the next year? What investments should be avoided?
A. It's critical that people think about their investments through the lens of their own personal financial situation, cash flow, emergency cash levels, debt levels and align decisions with their short, mid-range and long-term goals. There may be investments that are out of favor in the next 18 months but still belong in a longer-term portfolio. I strongly advise against attempting to time the market.
In a recession, almost everyone has less room for speculation, so make sure every dollar is accounted for -- whether it's to boost emergency savings, buy a house, pay down consumer debt or save for retirement.
I'm taking on clients who have been over-exposed to large cap growth stocks and we're diversifying into a better blend covering both international and U.S. companies, as well as mid and small-cap companies. My portfolios have a "value" tilt, which means we like dividends as an important additive to total return.
The upside of volatility is that investors begin to value moderation and resiliency. It takes getting burned by too much exposure in one area or holding a concentration in one company that deflates fast for an investor to understand the value of diversification and dividends.
Hunter Holzhauer is the Robert L. Maclellan and UC Foundation associate professor of finance at the University of Tennessee at Chattanooga Gary W. Rollins College of Business. He currently teaches classes in investments, behavioral finance and managerial finance. He is also the faculty director for the UTC Student-Managed Investment Learning Experience (SMILE) Fund and the faculty advisor for the UTC CFA Investment Research Challenge Team.
Q. What is your outlook for 2023? Do you expect stocks to rebound?
A. First, most people are bombarded with negative news. News is generally negative because that catches people's attention. I do think the chance of a recession is real, but don't think it's as scary as it's made out to be.
If I had to make a prediction, it would be for a soft landing or a mild recession for the U.S. I would suspect Europe is more exposed to problems relating to the Ukraine and the energy crisis, so they would probably be more susceptible. If they make it through this winter, may have more options next winter. Asia would be hard to predict.
There are a lot of variables with the Ukraine and then also if we were to have shutdowns again with COVID-19. And the Chinese economy can have ramifications all over the world, especially in retail centers because they make so many goods for so many countries.
Most people want this to get over and done with, but that's not what's most likely to happen. We just had a global health epidemic, and now we have fighting in Ukraine. If we were to get a third factor that comes out of nowhere, or if our current situation were to become less stable, we could have some big economic trouble.
I would say there is a small chance, depending on actions by the Federal Reserves -- there is a small chance the recession could come in 2024 or later. If they give the markets more of a "heads up," they can react quicker. And opposite. I wouldn't be surprised if it looks like we're doing OK, but then it happens in 2024.
I say all that, yet, personally, I remain optimistic. We get more negative news than positive, yet the market tends to go up over time and not down. I would encourage people to continue to put money into 401K accounts and not pull out due to fear. And also, diversify investment portfolios. Work with a financial planner to mitigate risks.
Q. What advice would you offer to small investors right now?
A. If you're going to look at stocks, during past recessions, the standard advice was to invest in more defensive stocks rather than cyclical. With defensive stocks, you're looking for companies that aren't going to go away, no matter how bad it gets, and that could maybe even benefit from a recession.
An example of that might be Walmart -- lots of the goods sold there that people are still going to buy. Another one would be health care. People are still going to go to appointments, and pick up prescriptions at the pharmacy. These are built-in cash flow streams. Utility companies would be an example. People will always need heating and water. Even some tech companies, like Apple, would be considered defensive. Nobody's going to stop using computers or cell phones just because we're in a recession.
We've known a recession may be coming for a while, and so may have missed the right timing. Sometimes when people are looking to rebalance, they may wait too long. For example, Walmart has been going up since June.
One of the best things most people can do is not change their habits. Don't panic. Unless you're a professional investor, you're more likely to sell when down. But a lot of people will miss out on the good times by trying to time the market.
The stock market, based on all evidence, will continue to get higher, although that's not to say it won't hit a big hole along the way. Those who are invested for retirement should stay. If they're going to invest in individual stocks, I would recommend investing in stocks they know and understand with cash flow streams that will continue to flow into the future.
Ringgold, Georgia resident Terrence Tully relocated to the area about five years ago from Long Island, New York. This year marks his 20th anniversary working at Schenck USA, a company based in Long Island that produces high-end balancing machines for manufacturing equipment such as pumps, impellers and rotors down to dentist drills. In his position as a network manager, he travels weekly to various office locations throughout the U.S. At age 64, he is on the cusp of retirement.
Q. How have the last couple years been for you, in terms of watching your 401(K) and the stock market fluctuations?
A. Well, when we look at 2022, of course it's been a little depressing. Watching the S&P 500; which applies to most 401(K)s, was depressing. It was down 19%, and that was pretty painful. If you assume most people have a mix of stocks and bonds, 401Ks could be down 15% this past year.
But performance in 2021 was +27%. So much volatility. If you watch it daily, you can lose your mind.
It certainly makes you think twice about retirement. Do I have enough now? Can I expect the same annual "paycheck" while retired now? What adjustments do I make now to my standard of living?
Suppose you have a million dollars in your 401(K) and you've decided you'll withdraw 5% each year. Based on a million dollars, that equals $50,000 for next year. But then the market contracts 20% and your 401K is now at $800,000. So 5% of this is $40,000. You've taken a pay cut of $10,000.
But it's not the end of the world and isn't forever. Let's say the market goes up 12% next year and your balance is back up to $900,000. So for the next year, 5% of $900,000 is $45,000. You got a raise of $5,000.
Obviously, this is a simple example and not completely accurate. I'm just pointing out that the amounts will fluctuate, so you can make adjustments annually and move forward with retirement. You don't have to delay retirement just because it was one bad year in the market.
Sadly though, I know people who will continue working because of the volatility. They continue waiting for that "good year."
Q. Have you postponed your retirement due to stock market volatility?
A. Originally, I started thinking seriously about retiring two or three years ago. Financially, it was feasible with the exception of one major problem -- health insurance.
The marketplace was very unstable. Government was trying to get rid of the Affordable Health Care Act at that time. And one thing is certain about retirement -- you must have health insurance. The risk is huge and you could go bankrupt if not covered.
Many people don't realize, but before the Affordable Health Care Act, buying health insurance on your own was very difficult and very expensive. One pre-existing condition as common as high blood pressure would prevent you from getting covered, or would cost an exorbitant amount. Of course this problem ends when you turn 65 and enter the world of Medicare.
I would like to retire at the end of 2023. I think about it a lot, but mentally I bounce back and forth. I still question the finances. Many people I talk to feel the same. It's a bit nerve wracking to imagine taking money out of your 401(K). We've spent all these years putting money in and watching it grow.
So, have I postponed retirement? Not because of the stock market. It will continue to grow. The S&P's last four years performance was -19, +26, +16, and +28. So, I hope this year turns back positive again.
Q. Have you made adjustments in how you invest?
A. I also have an investment portfolio that is part of my retirement plan. It is the third piece of the "retirement pie" -- Social Security, 401K and personal investments.
With that, yes, definitely. A full 40% of my personal portfolio is in cash right now, sitting by idly doing nothing, unfortunately. You're kind of riding the sidelines when you get a year like this, which still hurts because you're losing to inflation -- but it's -8% inflation rate which is better than -19%. I do buy and sell individual stocks and funds regularly though in this account.
My 401(K) is fully invested, as many company 401(K) plans don't have the option of sitting on cash.
This year was tough for conservative 401(K) accounts, as well. Normally, you have stocks and bonds. And historically, bonds have always been a safer place to invest. But this year was unique because it was horrible for both. There was no good place to put your money. Probably the mattress -- take it all out, and you would have been 20% ahead.