Stranger Things: An Early-1980s Flashback  

Market conditions (and risks) we haven’t seen in 40 years are back. Here's how to help prepare clients.

By Ron Pac

The last time financial markets were this distressed, the Gipper was wrapping up his first year in office and Christopher Cross’s “Sailing” was Song of the Year. Not only is inflation at its highest point (9.1%) since 1981, the equity and bond markets also continue to take a beating. As of June 30, stocks were down 20% to 35% across benchmarks from their 52-week highs and the Bloomberg US Aggregate bond index lost 11% for the first half of 2022. [As of press time in early August, stocks rallied a bit and the US Agg was down nearly 10% over the last year.]

Much of this can be attributed to uncertainty regarding Fed rate hikes, the war in Ukraine, global food and energy shortages, and the ongoing lockdowns in China, all of which are likely to cause even more supply chain issues than we’ve already seen as a result of the COVID-19 pandemic.

The takeaway for advisors is clear: Your clients need your knowledge — and your empathy — more than they have in decades, especially if they happen to be retirees or pre-retirees with increased vulnerability to a downturn of such historic proportions.

What’s happening in today’s market?

Inflation continues to surge, eroding purchasing power

The consumer price index for food rose 10.4% for the 12 months ending June. That’s its largest 12-month increase since the period ending February 1981 and the first double-digit increase in more than four decades. Inflationary pricing is estimated to cost U.S. households an additional $5,200 by the end of the year — hardly a low hurdle for those living on fixed incomes.

This is catalyzing the Fed to take a much more hawkish stance on monetary policy, with expected rate hikes to rise well beyond the target range to 3.4% by the end of 2022 and 3.8% in 2023.

Growth stocks are down

With the onset of a recession looming, this decline is to be expected. Tech in particular has been getting hammered, with no support coming on the bond side to offset losses. At the close of Q2, the S&P 500 had posted its worst first half since 1970 and the Nasdaq was down 31% from its prior November high. Amazon, Apple, Meta, Netflix, and Tesla all posted double-digit losses ranging anywhere from 22% to 71%

Although most younger clients understand that they’re better positioned to recover their losses because of the decades of earning years ahead of them, the fact is that sell-offs like these are making everyone nervous and are directly impacting older clients who are already drawing on their retirement savings or who are close to doing so.

Commodities and consumer staples are making a comeback

U.S. oil prices have rebounded to top $100 per barrel, and the international benchmark, Brent crude, is also up. Consumer staple companies such as Albertsons Companies Inc. (47.4%) and The Kroger Co. (36.3%) are showing significant increases in 12-month trailing total return.

In a non-inflationary environment, these assets are typically flat or depressed. As a recession becomes increasingly likely, however, it may make sense for some clients, when appropriate to diversify with 18% to 22% in commodities in their portfolios.

Clearly, the markets are undergoing a profound shift. A winning portfolio from even one year ago might be extremely risky today. Let’s take the long-venerated “safe” 60/40 portfolio as a prime example.

Inflation and rising interest rates are a problem for 60/40 portfolios

For decades, investors have poured trillions of dollars into the 60/40 portfolio mix. As you know, the thinking is that 60% invested in stocks will drive returns while 40% invested in bonds will provide the ballast during volatile markets, with both assets forming the core building blocks of a long-term portfolio.

Despite what’s become an annual ritual within the industry of declaring the 60/40 mix “dead,” the strategy has held up well, generating positive returns in 11 of the last 12 years and yielding a slightly better than 3% overall rate of return above inflation since the 1980s.

However, the prospect of higher interest rates makes it difficult for bonds to carry their role as a potential defensive hedge. And with bonds yielding less than the inflation rate, investors could likely abandon high-quality bonds for high-yield ones, further driving down bond prices. With the stock market teetering on the high valuations of U.S. large-cap stocks, equity investors appear to be looking at prolonged mediocre investment performance.

All of which may signal a change in what has long been considered one of the safest strategies for diversification. At least until market conditions become more conducive again.

Investors have changed, too

Changes in the economy aren’t the only things affecting the health of your clients’ portfolios. Where they are in their lives and careers is having an impact, too.

  1. Age. Forty years ago, many of your clients were just starting out in their careers, earning less and starting with a smaller balance sheet in their portfolio.
  2. Net Worth. Since that time, your clients have likely amassed a good deal of wealth in their portfolio.
  3. Risk Tolerance Level. Any investment is usually worth growing and protecting. That’s a given. What’s also a given is that younger investors with fewer assets and a longer period for recovery and growth are often significantly more tolerant of market risks than older investors who have built up a sizeable portfolio and are planning or may already be living on a fixed income.
The stakes are higher now

The market conditions we’re seeing today, with high inflation and rising interest rates, may not have had much of an impact on your clients years ago when they only had $20,000 in blue chips in their retirement account.

But with a larger portfolio, the stakes are a lot higher.

“Doing Nothing” is not an option

What do most people do when they don’t know what to do? Nothing.

And in some cases, doing nothing can be an effective strategy. After all, not every investment opportunity needs to be taken.

But in situations like this, with widespread economic uncertainty, you may want to consider strategies that could help your clients and mitigate risk.

Remember, your clients are relying on your experience now more than they have in 40 years. They’re also leaning heavily on your compassion and your genuine concern for their financial wellbeing, particularly if they’re at increased risk from the precipitous downturn in the markets we’re seeing. Rallying around them will not only show them you care but will also allow them to confidently make informed decisions about their financial future.

Ron A. Pac, AEP, CFP, CHFC, RICP, is a managing partner with Trivium Point Advisory.




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