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As the year comes to a close, I like to reflect on what has transpired—and boy, is there a lot to unpack for 2022. This year witnessed some of the highest volatility in both stock and bond markets. In addition, as of early October, we were on pace for the worst annual performance for a 60/40 portfolio in history!
The past few weeks have seen both markets rally significantly, with bonds having one of their best 30-day stretches in the past decade. This is encouraging, but we’re not out of the woods yet. While inflation has shown some signs of cooling, more follow-through is needed since it remains far too high from a historical standpoint.
What does this all mean for an investor? During periods of extreme volatility, diversification is vital. While not always pretty, it always works. This year has taught us many lessons, but the biggest one should be the importance of risk management. We know that markets operate in cycles, yet investors too often get caught up in speculative investing. Can speculation pay off? Yes. Does it for most? No.
Tech Stocks
Tech stocks were the stock market’s darlings for much of the past decade and gave way to the acronym “FAANG.” The digital revolution went into warp speed during the pandemic, as technology enabled work-from-home, home fitness, home entertainment, and other capabilities. The performance of FAANG from 2013 to the end of 2021 was remarkable!
Facebook (now Meta): 1,101.25% total return = 122.4% annualized return
Amazon: 1,195.85% total return = 132.8% annualized return
Apple: 946.95% total return = 105.2% annualized return
Netflix: 4,483.28% = 498.1% annualized return
Google: 419.56% = 46.6% annualized return
The S&P 500 returned 288.2%, a 32% annualized return, during the same period. That return is nothing to sneeze at, but compared to the FAANG stocks, it seems rather pedestrian, doesn’t it?
Honestly, returns of this magnitude can be life-altering. The reality is that the bulk of these gains came well before these companies became the behemoths they are today. The issue is far too many investors allocate capital after a massive run-up. Unfortunately, this year has not been kind to such investors as many of these stocks have given up several years of gains in a mere 11 months.
Minus Apple, the rest have declined -33% to -67% this YEAR, while the S&P is -15.3%. The key here is how compounding returns work. A $100,000 investment in Netflix at the start of the year is now worth ~$46,890. To get back to even, Netflix stock would need to increase by ~114%, while the S&P 500 needs only ~17.5%, a much more feasible scenario.
Does this mean technology stocks are doomed? Of course not, but the situation is yet another reminder of how markets can turn on a dime and go much higher or lower than we imagine.
It is important to distinguish between economy-wide factors and company-specific ones. Rising rates, for instance, disproportionately impact tech stocks since their valuations are based on cash flows that are far off into the future. When rates increase, the present value of these cash flows declines at a faster pace. This affects the stock price, as the uncertainty around rates can cause large swings in both directions, including a recent one-day jump of 7.4% for the Nasdaq in reaction to positive inflation data.
Cryptocurrency
I don’t really know where to start, but even the biggest crypto enthusiast has to acknowledge that 2022 has been a disaster. The crypto industry, once valued at ~$3 trillion, currently sits at ~$900 billion.
Not only have the prices cratered, but countless scandals wiped investors out in a matter of days. Multiple collapses raised alarm bells, and the demise of FTX was the cherry on top.
Unfortunately, profitability and adoption are still open questions for the most hyped parts of tech. Blockchain and cryptocurrencies, for example, have struggled due to falling coin prices and worries over whether cryptocurrencies are a viable currency given how often scandals are occurring.
The issue is a majority invest in crypto as a means to make money. This is a dangerous proposition in any new asset class, especially one with little to no regulation and where very few actually understand what they are investing in.
Of course, not all cryptocurrencies are created equal, as some will thrive and prosper, but a majority are likely to fail; that is just the reality of a newly formed unregulated asset class. Regardless of one’s views on cryptocurrencies and the future of decentralized finance, it’s important to maintain diligence and construct portfolios properly to minimize portfolio risk.
The current market environment highlights the aftermath of valuations becoming detached from reality. In both good and bad markets, the question of whether and how much to invest in any asset depends on the risk and return characteristics relative to a balanced portfolio. The need for diversification and proper portfolio allocation have not changed.
With challenges among tech companies and in the crypto space in the headlines, investors ought to stay focused on the long run and maintain proper portfolio allocations based on their risk and financial goals.
Discuss your situation with a fee-only financial advisor.