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Investing Outlook: May 2022

2022-05-06, Michael Thompson

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Investing Outlook:  May 2022

It’s been a rough year for investors. The S&P 500 is down 13% YTD as of the end of April, while the NASDAQ is down over 20%. Popular explanations cite high inflation, China’s zero-COVID policy and the war in Ukraine. Bitcoin was unable to escape the suffering, dropping over 17% so far this year. Gold, which most experts picked as the worst investment for 2022, has been one of the few investments to hold its value (nominally at least) thus far in 2022. We can’t change history, so let’s focus on the current state of investments and see if it can guide our future actions.


Inflation metrics have mostly exceeded expectations for over a year now. Even after the initial ascent early last year, most experts expected a quick return to around 2% inflation. Unfortunately, above-expectation inflation metrics continue rolling in. This has pressured the central bank to raise interest rates (and unload its bonds). How much and how fast rates rise is the question today. If rates increase too much or too fast, the economy could fall into a deep recession. However, too little may keep inflation at undesirable levels.

The Fed is monitoring as much data as possible and trying to walk the tightrope of preventing recession and excess inflation. Many unpredictable events will steer this data and hence Fed policy. Unemployment metrics have thus far been positive, with the current unemployment rate at 3.6%. People are continuing to voluntarily leave jobs and pressure up wages. These two phenomena green light rate increases from the employment perspective. Experts think the Fed rate will exceed 2% by the end of 2022, with some predicting up to 3%.

All things considered, Vanguard expects GDP growth around 5.5% in emerging markets, 5% in China, and around 3.5% in Europe and the US.


Historically high equity valuations have persisted for some time. With this, many have anticipated a correction, or at least a major cooling off, in equity prices. However, historically low interest rates have fortified high valuations and kept prices afloat. In our 2022 investment outlook, we warned that this era seems to be coming to an end. The Fed’s promise to fight inflation is bringing an end to nearly 40 years of lowering interest rates.

With a 13% S&P 500 drop YTD, it’s been worse than most expected. Valuations have improved as prices have dropped, but they remain on the upper end of historical ranges. The trailing 12-month P/E ratio for the S&P 500, for instance, is about 24 at the time of this writing. The forward P/E is around 19. The average is around 15. Higher risk-free rates, if they set in throughout the year, could keep equity gains grounded. Not many people will buy equities if they can get almost as much yield with a "risk-free" alternative.

Growth companies relying on speculation of future profits have taken more of the downside this year, as expected. Future profits are worth less when inflation is high. Companies with proven earnings and below average debt appear more attractive when inflation and interest rates climb, particularly those with pricing power.

Vanguard recently provided a chart showing how various investments performed historically in prolonged periods of real rate increases. High-quality value, international and small-cap were the best performers. To many, some such stocks have seen unjustified losses as markets corrected this year. These may be good buys at this point.

Of course, for those of us that plan to continue buying stocks, there is a bright spot. Price drops and more attractive valuations should at least boost returns on our future investments. Continuing low interest rates and high equity valuations would spoil our future investments and jeopardize our retirement plans.

Ex-US Stocks

In addition to quality value stocks in the US, investors may look to attractive valuations in ex-US stocks, particularly China. Of course, lower valuations exist for a reason—higher risk. However, the people who’ve put the most research into this predict that ex-US will most likely generate higher returns in the coming decade. For example, Vanguard’s May 2022 Market Perspectives article disclosed their estimated annualized returns of 5.7 to 7.7% for ex-US equities over the coming decade. Compare that to just 2.8 to 4.8% for US equities.

ETFs like VXUS are an excellent way to gain international exposure in a diversified way. We believe diversification is paramount, particularly in ex-US equities. For example, if you had a significant investment in Russian equities this year, even if it was highly diversified within Russia, you would be in a very bad spot now.

Gold and cryptocurrencies

Gold has been among the few pleasant surprises this year, with a 3.3% gain to date. The GDX ETF—a basket of gold mining companies—has gained over 10% YTD. At the start of the year, most "experts" anticipated gold to be one of the worst performers. Yet another reason to shun short-term forecasts—even when the "experts" form a consensus it seems to be wrong as often as it's right.

According to CoinMarketCap, the total cryptocurrency market cap has dropped over 20% from about 2.2 trillion USD to 1.7 at the time of this writing. Bitcoin itself has shed over 17% YTD. While there was no consensus on how Bitcoin would perform this year, most predictions were much, much more optimistic.

Unfortunately, there’s no accepted way to value gold or Bitcoin. Unlike stocks and bonds, it’s essentially impossible to say what’s priced well. It’s simply a function of how much the next guy is willing to pay, which is too frequently determined by random headlines and human emotion.

The layers on top of Bitcoin (e.g. the Lightning Network), mostly developed in the last 24 months, facilitate cheaper and more frequent transactions. Such developments could greatly enhance the utility of Bitcoin for payments. This is particularly true in the web/gaming/digital world, where sufficiently cheap, high frequency payments could lead to new paths of revenue not practical with credit cards. If adopted, this could provide substantial demand for Bitcoin and catapult prices to new highs. However, it remains to be seen if/how governments may deter significant migration away from their official state currencies (which may become digital themselves soon).

Most would agree that there are an excess number of digital assets in total, including many “altcoins”, without any attractive qualities relative to others. Most of us expect the lionshare of these to lose all value in the coming decade. Assets that provide real-world utility will remain and take on all the digital asset market cap.


The bond market historically does well when equities slump, but not this time. High inflation and rising rates have led to the worst bond market since the 1980s. The 10-year treasury bond has almost doubled yield so far this year, from just over 1.5% to 3% today. This devalues existing bonds purchased with lower yields. The JPMorgan US Aggregate bond ETF and the Vanguard total bond market ETF are down about 10% YTD. The 40-year trend of decreasing interest rates and bullish bond markets may have ended in 2020 as we are likely stuck with rising rates for some time.

International bonds haven't fared much better. The Vanguard total international bond ETF is down over 8% YTD.

A good performer for those not investing huge sums of money has been the series I savings bond. We pointed out this inflation-adjusted bond in a February article. Buyers were rewarded with a 7.12% interest rate for the first 6 months, followed by a recently-announced 9.62% interest rate for the next 6 months (per the May 2 rate update). Compare that with mostly around 10% losses in equities and bonds elsewhere.


It's been a rough year so far, and the stage is set for additional interest rate hikes. Even "safe, risk-free" bonds have lost, and may continue to lose, substantial purchasing power. An exception may be the series I bond, but it won't provide a significant real return, after inflation.

Equity valuations have improved, but may still be too high if risk-free rates climb substantially. Exceptions may exist in high quality value stocks and ex-US stocks, but not without risk.

Bitcoin and most cryptocurrencies have stumbled this year, but the technology continues to improve. If some of these networks can deliver utility to the average person, and governments don't deter their usage, coins prices could increase significantly. The remaining coins, however, may become worthless over the coming decade.

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