Could your investments do better in the 2nd half of 2022? Pay attention to these factors

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For investors, the first half of 2022 was grim. Inflation emerged from seemingly nowhere to become a major economic problem. A surprise war in Europe added to global uncertainty and supply-chain shortages. Recession anxieties surfaced. And both stocks and bonds took it on the chin.

Some signs point to improvement, or at least stability, over the second half of the year. For stocks and bonds to make progress, these five topics and trends could be critical.

Going beyond politics

The upcoming midterm elections promise more political rancor and division, but getting them out of the way should help the stock market.

“One of the things we knew coming into this year was that 2022 will be a midterm year — and those have historically not been kind to stocks,” noted a commentary by LPL Financial.

Since 1950, midterm years have generated the weakest market results of the four-year cycle, with stocks in the Standard & Poor’s 500 index down 17.1% on average, peak to trough, during those periods. A setback of that magnitude was already exceeded in 2022, with the S&P 500 down as much as 23.5% earlier this year.

Whether or not we have seen this year’s market bottom, the good news is that stock prices eventually recover.

One year after midterm-year lows, stocks rise an average of 32% on average from those lows, according to LPL Financial. In years that follow midterm elections, the market logged gains every time since 1950, or 18 out of 18 instances. The next such year is 2023.

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Pushing inflation from the headlines

Surging inflation is the economic story so far in 2022, prompting the Federal Reserve to raise interest rates, undermining business and consumer confidence, eroding Americans’ buying power and pushing down stock and bond prices. This new inflation trend followed years of mostly mild increases in the Consumer Price Index.

“Analysts (like us) have been calling for inflation to peak several times in the past 18 months, only to be proven wrong,” wrote economists at Northern Trust in a midyear commentary.

Inflation probably won’t diminish sharply anytime soon, not with continuing supply-chain issues, disruptions caused by the Russian invasion of Ukraine, 11 million unfilled job openings and other catalysts.

But it’s important to remember that high inflation historically was more the exception than the rule. Consumer price gains in excess of 4% to 5% are unusual, and there are many reasons to expect the trend will ease by year-end.

Among these catalysts cited by Northern Trust: Energy prices have dropped from their recent peaks, shipping costs have fallen sharply and monetary policy has become rapidly more restrictive. Also, inventories are building up, reflecting increased pressure against retailers and suppliers raising prices, and layoffs are starting to rise again.

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Awaiting a possible recession

Inflation seems likely to abate sooner or later, which would bolster the financial markets. The question is whether a recession is necessary to get the job done. The jury’s still out on that one.

Given many still-solid economic indicators, a recession might not materialize for a couple of more years. Conversely, one might already have arrived.

Regardless, recessions or economic contractions are a normal part of the cycle, and they typically aren’t all that severe or long-lasting. The most recent one, in 2020, lasted just a couple of months, though it was sharp.

“Losses of national income and employment are modest” in most cases, said the Northern Trust commentary. “If that is the price that is to be paid for settling inflation for the long term, it might very well be worth the cost.” During recessions, laid-off workers bear much of the brunt, but any downturn in coming months would start from a low unemployment rate.

The stock market likely will bottom before a recession has ended and, possibly, before one is officially declared by the National Bureau of Economic Research. Investors are forward-looking, anticipating the eventual recovery, while recession pronouncements come in hindsight, often months after the worst has passed.

Getting cushion from bond prices

Diversification is the idea of not putting all of your eggs, or investments, in one basket. The idea is to ensure that you always have some assets that are rising or holding steady while others might be falling. It’s an intuitive concept that has worked well over time.

One key tenet is that you want to hold assets with varying degrees of riskiness — in particular, you want some bonds or bond funds to offset the higher volatility of stocks and stock funds. Equities have greatly outperformed fixed-income investments over time, but their higher returns come in fits and starts, not as a smooth ride.

“Over the years, bonds and stocks have played complementary roles in portfolio management, the foundation of which is built on diversification,” wrote Jack Ablin, chief investment officer at Cresset Capital Management, in a recent report.

From 1976 to 2021, stocks as represented by the S&P 500 index dropped in eight calendar years, and each time the bond market gained to ease the pain, Ablin noted. But that hasn’t worked lately, with both stocks and bonds stumbling over the first half of 2022. The roughly 11% first-half decline for bonds overall might be more notable than the 21% setback for stocks.

But with bond prices now down and yields up — they move inversely — bonds are probably closer to fair value than they were at the start of the year, Ablin figures. That should allow them to resume a more normal diversification role, helping to buffer the often-wild swings in the stock market.

Looking for a lift from Washington

Certain legislation also could support the stock and bond markets, such as by making retirement plans more appealing and accessible. If so, the Secure 2.0 Act might be the best bet for enactment over the rest of 2022.

The Securing a Strong Retirement Act of 2022 would update various savings rules, such as by boosting retirement-plan participation and delaying the deadlines for when investors must start withdrawing money from retirement accounts, noted the American Council of Life Insurers. The bill passed the House in March by a solid 414-5 margin but still awaits final action in the Senate.

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One provision would delay required minimum distributions, or RMDs, from Individual Retirement Accounts and 401(k)-style plans to age 75, from age 72 currently. Congress extended the age threshold from 70 ½ with the passage of the first Secure Act in 2019.

Also, the legislation would require automatic enrollment of most new workers in 401(k)-style retirement plans, lower plan-administration costs for small businesses and enhance the Retirement Saver’s Credit, a tax break available to lower-income workers that basically provides a source of federal government matching funds.

Other changes could enhance the use of annuities in retirement planning and make workplace retirement plans more widely available to part-time employees, military spouses and student-loan borrowers. It’s hard to plan bipartisan action in an election year, but this one might make it.

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