Lest investors have recently squashed out of memory, stocks, as measured by the S&P 500, don’t always have a good year. (See S&P 500 Total Returns by Year Since 1926) But over the last 13 years prior to this one, from 2009 to 2021, there have been positive returns in 12 out of these 13. And in the one year, 2018, when returns were negative, this widely followed index fell only 4.38.
Perhaps this has blind-sided many. Of course, the S&P 500 is highly correlated to the great majority of ETFs and funds, meaning that most returns have been nearly consistently positive for over a decade. In fact, S&P 500 returns have averaged over 15% annually through the period beginning at the start of 2009, but excluding 2022.
However, prior to 2009, fully 24 out of the preceding 83 years had negative returns, or about 29% as compared to a little more than 9% more recently. Another interesting fact: Out of these 24 years that had negative returns, fully 12 of the years were part of a sequence of two or more years of consecutive negative yearly returns, most recently during 2000, 2001, and 2002.
These facts should remind investors that the occurrence of negative yearly returns is not as rare as the recent 9% figure suggests. And more importantly, once a negative year plays out, 33% of the time, at least one or more negative years will follow.
So, we are not out of the woods yet as a result of the poor returns this year; another negative year, based on history, is somewhat likely to follow as well. While some pundits and investors may think they can say next year will be better due to an analysis of economic conditions, it is safer to assume that investors should not jump aggressively into new risky positions just because of one bad year of depressed major stock values; more below par returns may yet lie ahead. Add to this, a continuation of Fed rate increases, high inflation, and a downgrading of corporate earnings, and there appears to be a recipe for continuing poor stock performance.
Bond ETFs and funds, too, have had a monumentally bad year so far, perhaps the worst year ever according to several sources such as Forbes magazine (With The Worst US Bond Returns In History, Where Did Investors Go Wrong?)
Past Is Past, But What About Ahead?
In the remainder of this article, I will suggest what choices investors might still have to avoid potential subpar returns in 2023, or at least, keep potential negative returns to as little as possible.
Recommendation: Back one year ago in Dec. 2021, before inflation became as firmly entrenched as it subsequently became in 2022, I found that, based on historical data, once inflation averaged above 2% during a full year ending each December, the return of overall stock market that year, as measured by the Vanguard Total Stock Market ETF (VTI), tended to be quite low. (See VTI ETF Investors: Even Moderate Inflation Can Be Damaging).
I suggest that investors who believe that inflation in 2023 will continue to exceed 2% may still want to trim down their stock holdings, as turned out to be a wise decision if adopted at the beginning of 2022.
As we head into 2023, it appears highly likely that 2023’s year-end level of inflation will remain above 2%. However, if a recession does hit in 2023, accompanied by a large drop in inflation, and/or, the Fed begins to lower interest rates, both unlikely in my view, perhaps low stock returns next year can be avoided.
Recommendation: In Jan. 2022, I suggested that in spite of Vanguard Growth ETF (VUG) trouncing Vanguard Value ETF (VTV) for more than a decade, Value-focused ETFs of all capitalizations along with other Value-oriented funds are likely to be superior choices than Large Cap Growth ETFs or funds.
How have Value categories performed year-to-date, through Nov. 11, according to Morningstar.com?
Large Value -1.86
Mid-Cap Value -2.20
Small-Cap Value -3.26
Large Growth -35.15
Mid-Cap Growth -28.96
Small-Cap Growth -29.36
Due to factors explained in many of my earlier Seeking Alpha articles (for example, see here) as well as Newsletters (see funds-newsletter.com), and what appears to be the continued undervaluation of Value funds vs. Growth funds, I expect investors to continue to move toward Value funds for the foreseeable future, enhancing their returns.
Recommendations: In my next Seeking Alpha article in Feb. 2022 (How Popular Funds & ETFs Have Previously Fared When Rates Rose), I looked at past results for funds during three periods of rising rates. However, this data may have thrown me a curve ball. These results seemed to suggest that in spite of the rising rates, most of the funds I selected to examine did pretty well when averaged over the three periods. Of course, most funds now are not doing well, not by a long shot.
However, the current period of rising rates is not over; the Fed has promised more rate hikes to come. So, perhaps by the time the Fed is done (which may take an elongated period of time), returns may indeed be considerably better. Further, even when the Fed stops raising rates, some members have indicated they plan to hold rates steady to see how the higher rates are impacting inflation at that point. Thus, over these extended months, stocks may still surge, celebrating so to speak, the end, or near end, of the rising rate cycle. Therefore, it is still possible that stocks may do as well as I reported in the Feb. article.
It may be informative to look at the relative results for the 11 funds I selected in Feb. to examine the best and worst performing funds during the three previous periods of rising rates, and by likely implication, the fund categories they are drawn from. This data may yield clues as to which categories are likely to hold up best during the current period of rate increases.
Here is a list of the funds’ average annualized performances as shown in that article from best to worst:
Vanguard Energy Fund (VGENX) 25.6
American Funds Growth Fund of Amer A (AGTHX), Load Waived Class) 16.3
Vanguard Real Estate Index (VGSIX) 16.0
T. Rowe Price Financial Services Fund (PRISX) 14.5
Vanguard Emerging Markets Stock Index (VEIEX) 14.5
Vanguard International Growth (VWIGX) 14.1
Vanguard Small Cap Index (NAESX) 10.8
Vanguard Value Index (VIVAX) 10.3
Vanguard Total Stock Market Index (VTSMX) 7.8
Vanguard Total Bond Market Index (VBMFX) 5.2
Vanguard Growth Index 4.9 (VIGRX)
Returning to the current period of rising rates, Energy funds are the only category showing positive returns. Unmanaged Growth funds, as represent by the Vanguard Growth Index, have shown one of the worst performances. Therefore, it is possible that we may expect similar types of relative returns during the current period of rising rates. So, investors may want to include an unmanaged Growth fund such as AGTHX, Real Estate, Financial, and International ETFs/funds.
We may yet still see Real Estate, Financial, and International funds, as also reported in the Feb. article, as among your best choices during the current rising rate period.