2022 In Review: Silver Linings and Things To Come

Dear Clients:

Before I start on 2022, I want to transport us back to the end of 2019. The pre-COVID era, the pre-inflation era, the pre-Russia-Ukraine war era, the pre-the-world-falling-apart-era.

At the end of that “blissfully-ignorant-of-what-was-coming” year, the S&P 500 (a broad measure of the US stock market) stood at 3,230. It closed out 2022 at 3,838, giving a three-year return of 19%.

I mean, boy, that’s not bad when you think about what has gone on!

Just under three years ago the world started shutting down in a way that no one living today had ever experienced. From that came economic devastation and the fastest bear market on record. The Fed and other central banks around the world stepped in and coupled with the vaccine, we survived the crisis (as we always do). The market then roared to new highs and seemingly nothing would stop it.

(Something always does though, of course.)

This time, the ‘out of nowhere’ event was the Russia-Ukraine war. This, along with the limitless support that the Fed gave the economy during COVID resulted in inflation very suddenly reaching 8%, a 40-year high.

The Fed’s response to that was to raise interest rates quickly and decisively. Rates increased by 4.25% in 2022. This caused a major slowdown in the US housing market and toppled the US stock market. We entered a second bear market.

A second bear market. This is all in a 36-month period!

The second bear market lines up perfectly with 2022 – the high for the S&P 500 was 3rd January 2022. From peak-to-trough the market fell 27%. We have rallied a bit since October and the index ended the year down 18%.

This makes 2022 the 7th worst year for the US stock market since the 1920s.

It actually gets worse than that because normally when stocks are down, bonds are up. That’s what bonds are supposed to do – protect you from volatility. We try not to pay too much attention to bonds because we, long-term patient investors, are happy to ride out the volatility of equities to earn their superior return. But for traditional investors, those who might believe that risk and volatility are the same thing, bonds going down almost as much as equities – that was a real shock. 2022 was the worst year ever for US bonds – the Bloomberg US Aggregate (a broad measure of the US bond market) lost 13% in 2022, a loss that is 4x larger than the previous worst year (1994).

Add to that, a crash and collapse in the crypto market, 2022 might be one of the worst years that investors will ever see.

That’s the bad news.

There is good news:

If you are in the accumulation phase of life (working and earning) then we have you set up with a regular buying schedule. Buying in a declining market is psychologically hard, but financially incredibly rewarding. As the market falls your money buys more units. The units you buy at or near the bottom are the ones that will make you the most money in the long-run. The old saying ‘buy low, sell high’ really works you know (I didn’t make that one up myself)!

Given that we can’t know when we are at or near the bottom, the only strategy that works is to just keep buying (the title of an excellent new personal finance book).

Remember, every bear market in history was a buying opportunity when you look back with the benefit of hindsight.

How you wish you purchased stocks when the S&P 500 plummeted to 670 in 2009! How you wish you purchased stocks when the S&P 500 plummeted to 2,200 in 2020!

Luckily, with your plan in place you won’t have to look back on 2022 and wish you had purchased stocks. You DID purchase stocks. You purchased shares in the best businesses on the planet. Those businesses will endure and their prices will once again hit all-time highs and you will feel very grateful for the extra units you purchased this year.

And listen, if you don’t believe me on this point, believe Jack Bogle, one of the best investors of all time:

There is more good news!

Everyone is really bearish right now – that’s a great thing for markets. Risk is always lowest when it feels the highest and highest when it feels the lowest. To highlight that point – here are the ‘top US investment bank strategist’ (whatever that means) forecasts for the year end 2022, made at the beginning of the last year.

The S&P 500 closed the year just above 3,800. Not one ‘expert’ came close.

Obviously we pay absolutely no attention to such forecasts – they make astrology look respectable (to paraphrase John Kenneth Galbraith).

There is even more good news.

Savers had been punished over the last decade or so. With interest rates near zero there was no yield to be earned on cash. That changed this year. Although the banks are quick to increase borrowing rates they don’t have the same sense of urgency when it comes to your deposit rates. However, there are plenty of options out there to earn between 4-5% on cash-type deposits. We will be making this a topic of conversation in 2023, but if you have large cash balances that you want to keep on hand, drop us a line and we will discuss.

Back to equities; there have only been 7 double-digit down years in the S&P 500 since the end of the second world war – it’s quite rare for stocks to be down this much over a year.

What’s interesting is what happened after those years. This table shows the subsequent year return after a double-digit down year. You will notice there are only two times in this almost 80-year period that the market was down in a year after a double-digit decline. That happened in 1973/1974 and 2001/2002. Those were really bad times – I wrote about what was going on in the world during those bear markets here.

What I want you to focus on is the wildly positive returns that have mostly followed the down years – a median return approaching 30%. This is what we don’t want to miss.

Now let’s take a step back and remember why we invest and how we invest.

When we met you, we asked you what was important to you, who was important to you. We tried to understand what you dream of, the life you want to live, the legacy you want to leave. We explained that to accomplish those goals and dreams you have to earn a return on your capital that, at the very least, offsets inflation. We talked about risk and volatility and how they are not the same thing – in the words of Howard Marks, “there are many kinds of risks. But volatility may be the least relevant of them all.”

We made sure that you understood that the only way to capture the full return of equities is to ride out their frequent but historically always temporary declines. We apologized for not having a crystal ball and said we could have no way of knowing when we are at the top or when we are at the bottom.

We took everything you told us and we constructed a portfolio of the best businesses in the world. We constructed it as cheaply and efficiently as possible, explaining to you that this portfolio was not about ‘outperforming’ anything, but about ensuring you got your fair share of the global stock market returns.

You trusted us to be the stewards of your capital for multi-decade goals. We never put any short (or even medium) term money into equities. We said that equities were too volatile for your short-term goals and needs.

Behind your portfolio stands a plan. Behind the plan stands the wishes and dreams of you and your family. We know that lifetime investment success comes from acting continuously on a plan. And we know that lifetime investment failure most often comes from abandoning the plan and reacting to current events.

It’s the danger of – ‘I’ve got to do something’. Jack Bogle famously said, ‘don’t do something, just stand there’ (you will hear those words in his video shared above).

We help you do nothing when doing nothing is the right thing to do.

Stand fast, tune out the noise and continue to work your long-term plan.

The safety is in standing fast. You are in a canoe – it cannot capsize, even in the strongest rapids. If you jump out you will drown. If you stay in, scary as it is, you will be fine.

The last three years has proven that to be the correct strategy – despite the fact that the entire economic, financial, political and geopolitical world pretty much blew up, we did okay. We did okay.

Liberty Wealth Update

Most of you have now met Guy. And if you haven’t, you have conversed over email. After only seven months he knows all the workings of the company and can deal with any client issue or enquiry. Please do copy him in on your correspondence. He has his final CFA exam in February (passing will give him more letters after his name than me). Once he has put his formal study days behind him he will focus on taking on his own client relationships.

Thank you for being our clients. Thank you for allowing us into your life. It is truly a privilege.

We hope that our process has increased your peace of mind that your money is wisely invested and stewarded for your future, and that you have a plan in place to get you where you want to go. If you have friends or family that would benefit from the same process, we’re here to help them too.

Here’s to, above everything else, a healthy 2023.

Georgie

georgie@libertywealth.ky

guy@libertywealth.ky