Happy Fall. As we approach the end of a whirlwind year it is important to continue to look forward to what is on the horizon. Many of the events of the year have come as a surprise to many, along with how long they have lasted. This year has been full of events that don’t seem to come to an end; a war in Ukraine, record inflation, rising interest rates and a stock market that slowly continues to work its way down. In some situations, the protection that bonds normally provide has not been afforded to investors this year as some are down as much as equities. In these times it is critical for investors to take a step back and look at how this affects their overall financial picture. This is where the importance of financial forecasting and planning comes in. Often investors wonder what this means for their retirement and an updated cashflow and net worth projection allows us to see the impact. It is important to maintain perspective.
In the chart below you can see the red dots are the drawdown the market had during the year and the grey bar is the return at the end of the year. Historically, the S&P 500 drops 14%, on average, at some point during the year, every year. Every 5 to 7 years it drops 2-3 times that amount. What happens on the other side of the drawdown? We see some of the strongest performing years the market has had. This doesn’t mean next year will be a record setting year. What this does mean is it is important not to panic and keep your funds invested. Much of the correction we have seen to date has been more of a valuation correction. Companies are still showing growth in earnings but have started to slow compared to previous years. If we continue to see strong employment and continued earnings growth, we are likely to stay in a holding pattern until inflation and interest rates can begin to normalize.
The fixed income market has been a disappointment this year to everyone and in particular conservative investors. Bonds lose value when interest rates increase because there are new bonds being issued at higher rates that are more desirable. A bond market drawdown to this extent is rare and often feels worse when it aligns with a stock market decline. The bond market does have hiccups but normally not to this degree. The decline in bonds has been caused by a quick rise in interest rates within the year. It does appear as though the rate hikes will slow going forward, this should provide some stability to bonds. In the future when rates are lowered again there will be some capital appreciation to be had with bonds.
Inflation has been another concern for many Canadians this year as they watch the price of gas, groceries, and everything else continue to rise. Inflation is due to many factors such as supply chain issues, the war in Ukraine, but the main reason is the influx of cash pumped into the economy by the government during COVID. It does seem inflation peaked in July and is now trending downwards. We received another 50 basis point increase on October 26th and the Bank of Canada’s next interest rate announcement is on December 7th. This has been one of the fastest tightening cycles with the Bank of Canada raising rates by 3.5% since March of this year. The Bank of Canada has discussed slowing the rate hikes as they see supply chain issues come under control and see inflation/inflation expectations continue to drop.
Many investors ride the emotional rollercoaster with every move that the market makes. In good times, investors get excited and often want to put more money into the market because everything is going up and this results in them “buying high”. When markets move downwards, many investors start to think of moving to cash or putting everything in GICs to avoid any further losses - this often happens at the bottom of the market. Many investors will attempt to time the market and this often results in investors ending up in a much worse position. Each time an investor attempts to buy back in at a lower price they need to be correct twice. They will need to pick the proper time to both exit and re-enter the market. In the end it is critical to stay disciplined and committed to your long-term investment plan and avoid riding the emotional rollercoaster.
In these uncertain times it is always important to remember that these downturns are temporary. The issues that we see in the market will work their way through. Speak with your advisor about your plan if you have any concerns on how it will affect your lifestyle. I wish everyone the best as we move towards the end of this crazy year we call 2022.