Opportunity Beckons

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We’re in another “bear market,” which is defined by our industry as a market decline of 20% or more from a previous high. Inflation, rising interest rates, and a war in Ukraine with a nuclear power are most often cited as the reasons today. Or maybe it’s this: 

From March 2009 to December 2021, the S&P 500 Index rose a total of 740%, or 18.0% annually. That’s 12 years and 10 months of historically high returns given that the annual return for the market index prior to that period (starting in 1928) was 9.0%. In other words, the market performed on average twice as well (100%) for almost 13 years prior to this decline. We were due. 

The correction is particularly painful since our go-to high-quality, short-term bond fund is down 7.3% on the year. It could be worse, however, as inflation-protected securities and long-term government bonds are down approximately 14% and 26%, respectively.* 

You can’t avoid inflation for long after pouring so much money into the economy, as almost every Western nation did over the past few years. Interest rates had to rise at some point, which means a drop in prices for already issued bonds. 

Was all of this predictable? Of course. You can’t benefit from stock returns at twice the long-term average and not expect a correction at some point. That “point” is what is unpredictable. 

In any case, as you can see in the green bars above, small cap and value stocks have fared better, so far, in this correction. In contrast to the total stock market, since March 2009, US large and small value stocks (using Dimensional indices as proxies) rose 611% (16.5% annually) and 825% (18.9% annually), respectively, through the end of last year. Those annual returns were “only” 59% and 51% better, respectively, than their long-term averages (10.4% and 12.5%, respectively). 

Price-to-earnings ratios currently for US small value stocks and international large and small value stocks range from 7.1 to 7.9. This results in “earnings yields” ranging from 12.7% to 14.0% (the inverse of the P/E ratio). Many investors use the earnings yield as an indication of overvalued or undervalued stocks by comparing it to bond yields. The market is pricing small cap and value stocks very cheaply. As a comparison, the S&P 500’s earnings yield in 1999, prior to the “dot-com crash,” was only 3% (based on a P/E of 33). Today, its P/E is 17.9, for an earnings yield of 5.6%. 

While this correction can be stressful, we’ve enjoyed historically high returns for quite awhile, and our small cap and value tilts have cushioned the blow from this correction. All in all, not bad. For our clients who cannot add to their portfolios at this time (typically due to retirement), the normal course is to take required distributions from cash and/or their bond fund as much as possible and rebalance portfolios as appropriate. 

For those still adding to their portfolios, these lower stock and bond prices offer a rare opportunity to take advantage of higher expected returns in the future. Since you’re already paying much higher prices now for food, fuel, mortgages, and just about everything else, why not be a wise contrarian who recognizes the long-term value of falling prices in the short term and jump in? 

Just know that this too shall pass, and those who keep their heads will prosper while those who panic and change their long-term plans may miss an incredible— and fairly rare—opportunity. 

*Using the DFA Inflation Protected Securities Portfolio and the Long-Term Government Bond Index as proxies. 

Equius Partners, Inc. is a Registered Investment Advisor.

Past performance is not a guarantee of future results. The data and information set forth herein are provided for educational purposes only and should not be considered tax, legal or investment advice; a solicitation to buy or sell securities; or an opinion on specific situations – as individual circumstances vary. There is no guarantee an investing strategy will be successful. Investing involves risks, including possible loss of principal. Diversification does not eliminate risk, including the risk of market or systemic loss.

Please consider the investment objectives, risks, and charges and expenses of any mutual fund and read the prospectus carefully before investing. Indexes are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio.

© 2023 Equius Partners, Inc.

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