David Helscher

David Helscher

During the intensely volatile first part of 2022, the stocks of companies in the S&P 500 index delivered their worst performance since 1970.

The S&P 500 continued to move lower, descending into a bear market — typically defined as a sustained drop in stock prices of at least 20% — on June 13. Some investors who are nervous about the future and their portfolios seem to have taken a defensive stance by selling riskier assets, including growth-oriented technology stocks.

Throughout 2021, U.S. businesses dealt with unpredictable demand shifts and supply shocks related to the pandemic; but, near-zero interest rates and trillions of dollars in pandemic relief supported consumer spending, boosted economic growth, and drove record corporate profits.

Companies in the S&P 500 posted profits in 2021 that were 70% higher than in 2020 and 33% higher than in 2019, which helped fueled a stock market total return of nearly 29%.

But in the first months of 2022, investors began to worry that the anticipated tightening of monetary policies by the Federal Reserve — to cool off high inflation — would stifle economic growth and cause a recession. Prices began rising in the spring of 2021 due to high demand, supply-chain issues, and a labor shortage that pushed up wages. Inflation picked up speed when China’s COVID-19 lockdowns impacted the supply of goods, and Russia’s invasion of Ukraine sent already high global food and fuel prices even higher.

The relentless acceleration of price increase puts pressure on the Federal Open Market Committee (FOMC) to act aggressively to tame inflation. At the beginning of May, the FOMC raised the benchmark federal funds rate by 0.5% (to a range of 0.75% to 1.00%). This was the first half-percent increase since May 2000, and Fed projections suggests there will be more to come.

On June 15, the FOMC further increased Fed Funds by 0.75% (to a range of 1.50% to 1.75%), the largest single increase since 1994. In their accompanying comments, the FOMC anticipated further increases at subsequent meetings before the end of the year. The FOMC meets again in July.

Rising interest rates push bond yields upward, and the opportunity for higher returns from lower-risk bond investments makes higher-risk stock investments less attractive. Moreover, stock investors are buying a portion of a company’s future cash flows, which become less valuable in an inflationary environment. Higher borrowing costs can also crimp consumers’ spending power and cut into the profits of companies that rely on debt.

Stocks in the information technology sector have been hit harder than the S&P 500 as a whole. Plus, like many benchmark indexes, the S&P 500 is weighted by market capitalization (the value of a company’s outstanding shares). This gives the largest companies, most of which are in the tech sector, an out-sized role in index performance.

As of May 31, the information technology sector still accounted for 27.1% of the market cap of the S&P 500, compared with weightings of 14.4% for health care and 11.2% for financials, the next largest sectors. Apple, Microsoft, Alphabet, and Amazon are the four most valuable companies in the index. For the past several years, tech stock gains drove the market to new heights, but when their share values began to drop, they dragged the broader stock indices down with them.

A Wall Street Journal analysis of market data through May 17 found that just eight of the largest U.S. companies, the four previously mentioned plus Nvidia, Meta, Netflix and Tesla, were responsible for an astounding 46% of the S&P 500’s 2022 losses (on a total return basis).

If you feel shell-shocked after more than 5 months of market turbulence, try to regain some perspective. Some analysts view recent price declines as a painful but long overdue repricing of stocks with valuations that had grown excessive. Spreading investments among the 11 sectors of the S&P 500 is a common way to diversify stock holdings, but over time, a portfolio that was once diversified can become overconcentrated in a sector that has outperformed the broader market.

So, you may want to look closely at the composition of your portfolio and consider rebalancing.

It could be a while before investors can better assess how the economy and corporate profits will ultimately fare against inflation and higher borrowing costs. Disappointing economic data and company earnings reports could continue to spark volatility in the coming months.

It may not be easy to take troubling headlines in stride, but if you have a sufficiently diversified, all-weather investment strategy, sticking to it is often the wisest course of action.

David Helscher is a senior vice president and trust officer with Clinton National Bank.

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