Inflation has lain dormant for so long that even the stock market statisticians have forgotten they need to adjust investment returns for it. Or perhaps they just want to avoid concluding the obvious in public. That it was the worst year ever for investors.
You might’ve seen articles that it was the second or fourth worst year, depending on the political leanings of the newspaper you read. As ever, it’s a game of picking and choosing numbers to get the conclusions you want.
Given my penchant for Funniest Home Videos and the like, you can guess I enjoy a bit of morbid humour. And financial markets certainly delivered that in 2022. But was it really the worst year ever?
Sort of…
Here’s the cherry-picking filter I’ve used to get to my own preferred conclusion…
First of all, I’m focusing on American investors’ experience investing in US markets. Why? Because that’s the only statistic by which the year really was such a record-breaking debacle.
Aussie investors in the US market might notice that their assets didn’t go down nearly as much as the media dramatised. The difference is the exchange rate. The US dollar surged, so Aussie investors’ currency gains offset some of the US markets’ losses.
You could even say that US stocks and bonds didn’t really crash particularly horrifically in 2022. Instead, it was the US dollar that surged. That pushed down US prices.
Think of it like this: if the definition of a centimetre changed from 10 millimetres to 11 or 12, then the size of everything would suddenly be a lot smaller…to the extent that we use centimetres to measure it.
In much the same way, the US dollar, the global measuring stick for prices, surged almost 20% to September but then corrected down so that it only finished the year up about 10%. This change caused chaos in USD prices because the unit of measurement changed. It was suddenly worth more.
Aussie investors looking at their AUD-denominated investments in the US likely didn’t notice much shift. Because the rising US dollar offset their losses in terms of Aussie dollars.
US investors weren’t so lucky. They weren’t protected by the US dollar’s surge in foreign exchange markets. And so bore the full brunt of falling asset prices instead.
So that’s the first filter I’m using to reach my conclusion that it was the worst year ever for investors — US assets as measured for US investors.
The second filter for my ‘the worst year ever’ claim is that I’m focusing on a 60/40 portfolio — the cookie of the cookie-cutting financial advice industry. This model portfolio, espoused by assets-under-management-compensated professionals, is a 60% allocation to stocks and 40% to bonds.
The idea is that when risky stocks have a bad year, safe bonds will go up instead. Thus, an allocation to bonds and stocks combined adds stability to the overall portfolio but still offers good returns (for those collecting the fees).
As you age, you’re supposed to add more bonds to make the portfolio even safer. Except, of course, that 2022 was the year in which bonds proved to be not safe at all. And, worst of all, this came to light in a year when stocks plunged too.
While US stocks plunged 19% in 2022, US Government bonds were down about 15%, depending on which ones you measure.
This is an extremely rare combination. In fact, the whole premise of the 60/40 portfolio is that this combination won’t happen. Stocks and bonds are supposed to be negatively correlated. Bonds are supposed to save you from bad years in the stock market and vice versa.
The only other time in the last century when US Government bonds fell by double digits was 2009, when the stock market began an epic recovery, offsetting those bond losses as they’re supposed to.
As I won’t bother digging into below, most of the other disastrous returns for the 60/40 portfolio featured years when stocks crashed so badly that mediocre returns in the bond market didn’t offset the losses. But 2022 was different in that both stocks and bonds fell, dramatically worsening the overall performance of a 60/40 portfolio.
So that’s filter two — the 60/40 portfolio and its failure in 2022. A failure which comes in at a return of -17% for the year for Americans investing in US assets.
Filter three is an especially awkward one. It’s the calendar year.
You see, 2022’s plunges coincided quite nicely with the calendar year. This makes things very convenient if I’m trying to claim that it was the worst year ever, right?
Other crashes might’ve started at the end of 2007 and finished in 2009, splitting the chaos into three separate years, dramatically reducing how bad the crash looks if you compare the calendar years separately.
A 2022-type crash that begins in July and ends in June might not even register on the list of record breakers as measured by calendar years.
But 2022’s crashes timed things nicely for my purposes today. The peak was in the final days of 2021, and the Santa rally of 2022 faded, even if we didn’t finish on the lows of 2022.
Compare the performance of an American’s 60/40 portfolio during other 12-month periods and you might come up with completely different conclusions to the one I reach today…
Even then, 12 months is arbitrary too…
As you can tell by now, advertising the good or bad performance of investment assets is surprisingly easy…
But it’s adding in inflation which everyone else seems to have missed. And my fourth filter is what makes things especially miserable…for US investors…who bought into a 60/40 portfolio…in January 2022 and sold it all in December 2022…
Using all the same constraints except inflation, the website A Wealth of Common Sense calculated that the drop in stocks and bonds was the third worst year for a 60/40 portfolio since the 1920s. First and second place go to the Great Depression’s 27% and 20%. To this, we compare our 60/40 portfolio’s performance of -17%.
Not quite as bad, but still in third place, right?
But wait, what about the 7% inflation Americans experienced in 2022? That’d make their real return -24%. Still only in second place? Not once did you adjust for deflation during the Great Depression…
According to the Minneapolis Federal Reserve, US inflation in 1931 was -8.9%.
No doubt this sounds apocalyptic…if you have an education in economics and your spouse does the shopping. For the rest of us, falling prices are quite good. They left the US 60/40 investors with an 18% loss in real terms in 1931, for example.
Which is a lot less dramatic than the 24% losses of 2022.
And so, yes, 2022 really was the worst year ever for investors. US investors holding a 60/40 portfolio for the calendar year, that is. Those who held tech stocks or more risky bonds did even worse.
But that’s hardly my point, isn’t it? My point is that such figures likely reflect the bias of the person using them more than the experienced reality of…you.
And that’s inherently so. There is no way to present entirely accurate or relevant figures. We must use arbitrary ones. But please do remember to keep those distinctions in mind. They might be determining the conclusions.
Until next time,
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Nickolai Hubble,
Editor, The Daily Reckoning Australia Weekend
