The Best Offense is a Good Defense

June 26, 2022

The S&P 500 stock index formally entered a bear market on June 13th, which means the index is down more than 20% from its prior all-time high set on Jan 4th.[1] This marks the S&P 500’s first bear market since the March 2020 COVID market crash, and only its second bear market since the Global Financial Crisis of 2007-2009.[2] Other global stock market indexes have also declined this year, some more than the S&P 500 and some less. Global bonds markets have not fared much better.

A variety of factors seem to be contributing to these current market sell-offs, with arguably the most prominent being high levels of inflation worldwide combined with responses from policymakers like the U.S. Federal Reserve aggressively trying to bring inflation back down to sustainable levels.[1] While we are rooting for their success, we believe there is a rising risk of at least a mild recession as well as a more prolonged bear market for stocks over the next 6 to 18 months.

High inflation is generally bad news for nearly everyone, including most investors. Historically, sustained levels of inflation greater than 4% have kept average S&P 500 returns below 2% per year and U.S. GDP growth below 3% per year.[3] This is for good reason – inflation is akin to a broad tax on goods and services, and there is not an inflation “tax break” for even the most vulnerable and lowest income households. In fact, just the opposite; the lowest income households tend to spend the highest percentage of their income on big inflation drivers like rent, gas, and food.[4] As high inflation persists, consumers are unable to afford as many goods and services as before, causing corporate sales and earnings to fall, and stock prices tend to decline in anticipation of this occurrence. Rising interest rates also tend to have a dampening effect on stocks.[5]

The U.S. Federal Reserve and other global policymakers are taking dramatic action to rein in inflation, and their main course of action is raising interest rates. They increased our national benchmark federal funds interest rate 0.25% in March, another 0.50% in May, and 0.75% in June[6] – the largest such increase since 19947 – and odds are high we’ll see another 0.75% increase in July.[8] Meanwhile, market participants appear to be positioning portfolios more defensively[9] as they watch to see whether higher rates can bring down inflation without also slowing down the economy so much we end up in a recession.[10]

We share this concern at Sapient, and we have positioned portfolios defensively for some time now. We sensed we were getting into the late stages of the market cycle, which tend to be characterized by high stock price valuations, high corporate profit margins, low levels of unemployment, and rising wages. The latter two generally pave the way for rising inflation and higher interest rates, which is where we find ourselves today. While we didn’t anticipate inflation would hit so suddenly, we are glad we prepared ahead of time. If this extended bear market scenario plays out as described, we intend to take advantage of more reasonable stock valuations to thoughtfully pivot from defense to offense in portfolios. As Warren Buffett famously said, “Be fearful when others are greedy, and greedy when others are fearful.”

Patience and commitment to a long-term strategy should serve investors well during this challenging period. Thank you for allowing us to steward your investment capital with great care.


1. The Wall Street Journal, June 13, 2022

2. Investopedia, June 16, 2022

3. Charles Schwab Quarterly Chartbook for Q2 2022

4. CBS News, June 14, 2022

5., May 11, 2022,an%20economist%20at%20Wellesley%20College.

6. The, “Fed Funds Rate History”

7. CNBC, June 20, 2022

8. CME Group, “FedWatch Tool”

9. CNBC, April 27, 2022

10. The Economist, June 2, 2022

Although the statements of fact and data in this report have been obtained from, and are based upon, sources that the firm believes to be reliable, we do not guarantee their accuracy, and any such information may be incomplete or condensed. All opinions included in this report constitutes the Firm’s judgment as of the date of this report and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Past performance is not a guarantee of future results. Indexes, such as the S&P 500 Index, are not directly investable.

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