Skip to content

Investment Commentary

Coming Attractions

By Brian Schaefer | Johnson Financial Group • November 18, 2022

3 minute read time

I saw a strange movie last weekend called The Banshees of Inisherin. The film has a 92% Rotten Tomatoes rating (very good) and an 87% Metacritic score, suggesting universal acclaim by both average moviegoers and critics. I thought it was a dud.

I think I was most annoyed by the fact that the stunning cinematography (the film takes places on an island off the coast of Ireland) and phenomenal acting was wasted. Colin Farrell and Brendan Gleeson play long-time drinking buddies (Irish Pub-style) whose relationship has soured amid the latter character’s reflections on mortality. There were many promising roads this story could go down, but the one it chose was both unexpected and unsatisfying. The best part of the movie for me was a cute miniature donkey named Jenny.

It seems to me that a bad film is a decent metaphor for what investors have experienced this year. Bond investors, in particular, have faced an unexpected and deeply unsatisfying storyline. Sure, we knew bond yields were low to begin the year, and we cautioned investors to expect muted returns from fixed income. However, few foresaw unrelenting inflation and one of the fastest interest-rate hiking cycles in history.

“Have my bonds helped?”

During a portfolio review recently, a client asked me, “Have my bonds really helped me at all?” He was asking if the diversification among stocks and bonds that we often preach was working. My answer was no doubt unsatisfying: “Yes, but not nearly as much as you would expect in a normal stock market drawdown.”

As the chart below illustrates, the most widely followed bond index, the Bloomberg Barclay’s U.S. Aggregate, was down 15.72% through October 31, just slightly better than the S&P 500’s 17.72% decline. Core bond portfolios with shorter average maturities fared better than the Aggregate Index, but nonetheless it’s true that bonds and stocks have moved together in the wrong direction for most of the year.

Bloomberg Barclay’s U.S. Aggregate, was down 15.72% through October 31, just slightly better than the S&P 500’s 17.72% decline

2023 and beyond: A redemption story?

After this painful rout across equity and bond markets, investors are wondering where the plot goes from here. I think we had a clue November 10, when the October CPI report showed that inflation rose at the slowest pace since January.

The inflation index increased 7.7% in October from the same month a year ago, down from 8.2% in September and materially below June’s 9.1% pace. This was the best evidence yet that the Fed may be making progress on its mandate to restrain price pressures. The S&P 500 shot up more than 5.5% in a single day, and Treasury yields fell dramatically. Falling yields translate into higher prices for bonds, meaning that both stocks and bonds had a historically good day.

I don’t mean to suggest that the markets are now off to the races and there won’t be any more pain ahead. Inflation is coming down because the economy is slowing. A slowing economy means higher unemployment and possibly a recession in 2023, which could crimp corporate profits. But the inflation report and investors’ reaction to it showed us light at the end of the tunnel and restored faith that this story will have a happy ending.

Indeed, for long-term investors looking forward, the multi-year setup is as attractive as it has been in years. Higher starting yields and lower stock valuations mean that stocks and bonds have the potential to deliver long-term returns more in line with historic averages.

We sometimes cite JP Morgan’s Long-Term Capital Market Assumptions when talking about expected market returns. JP Morgan and other research firms annually publish long-term forecasts for different asset classes based on current market conditions and certain assumptions about the future, such as GDP growth and inflation expectations. Last year, amid low yields and high stock valuations, JP Morgan anticipated long-term returns from a balanced portfolio of stocks and bonds of about 4.3% per year on average. As of September 30, with bond yields over 3% higher than they were to begin the year, and stock valuations lower, the forecasters had increased that number to 7.2%/year for a 60/40 portfolio.

increased that number to 7.2%/year for a 60/40 portfolio

We cannot, of course, predict the future. Like the weather in Ireland, markets can change quickly from day to day, but the farther out we look, the clearer the way forward appears, and the multi-year story to come may please even the harshest critic

SUBSCRIBE

Subscribe to Our Investment Commentary

We deliver unbiased guidance that's not in our best interest – it's in yours. Subscribe and receive our investment commentary straight to your inbox.

This information is for educational and illustrative purposes only and should not be used or construed as financial advice, an offer to sell, a solicitation, an offer to buy or a recommendation for any security. Opinions expressed herein are as of the date of this report and do not necessarily represent the views of Johnson Financial Group and/or its affiliates. Johnson Financial Group and/or its affiliates may issue reports or have opinions that are inconsistent with this report. Johnson Financial Group and/or its affiliates do not warrant the accuracy or completeness of information contained herein. Such information is subject to change without notice and is not intended to influence your investment decisions. Johnson Financial Group and/or its affiliates do not provide legal or tax advice to clients. You should review your particular circumstances with your independent legal and tax advisors. Whether any planned tax result is realized by you depends on the specific facts of your own situation at the time your taxes are prepared. Past performance is no guarantee of future results. All performance data, while deemed obtained from reliable sources, are not guaranteed for accuracy. Not for use as a primary basis of investment decisions. Not to be construed to meet the needs of any particular investor. Asset allocation and diversification do not assure or guarantee better performance and cannot eliminate the risk of investment losses. Certain investments, like real estate, equity investments and fixed income securities, carry a certain degree of risk and may not be suitable for all investors. An investor could lose all or a substantial amount of his or her investment. Johnson Financial Group is the parent company of Johnson Bank, Johnson Wealth Inc. and Johnson Insurance Services LLC. NOT FDIC INSURED * NO BANK GUARANTEE * MAY LOSE VALUE