Contributed by: Angela Palacios, CFP®, AIF®
2022 has brought steadily worsened news weighing on both stock and bond markets for three consecutive quarters. The Russia/Ukraine conflict, higher gas and commodity prices, a strong U.S. dollar, China's zero covid policy, supply chain disruptions, high inflation, rising interest rates, a minimum effective corporate tax rate, recession fears, and Cryptocurrency crashes have all wreaked havoc on investor sentiment. According to the AAII investor sentiment survey, as of 9/30/22, investors were only ever more bearish at four points in the history of the reading (8/31/1990, 10/19/1990, 10/9/2008, and 3/5/2009). "Unusually high bearish sentiment readings historically have also been followed by above-average and above-median six-month returns in the S&P500."
Raymond James recently wrote regarding severe recessions, "Recessionary bear markets have historically contracted 33% on average over a 13-month span. We are already down 24% (as of 9/29/2022) over nine months. Timing an absolute bottom is extremely difficult when uncertainty and volatility runs high. The index often capitulates at the bottom, reaching a low in sharp fashion for a very quick period, with very rapid recoveries. On average, the S&P 500 is up 16% in the first 30 days of a recessionary bear market bottom." This type of snap-back rally is particularly important to participate in for the success of a long-term investment strategy and is extremely difficult to try to time. We encourage investors to remain patient and trust in the financial planning process that plans for times like these to occur. Asset allocation, diversification, and rebalancing remain core tenets of our process during these times.
The FED is making up for lost time
The Federal Reserve continues to aggressively raise interest rates with an additional rate hike of .75% in September, making it the third consecutive .75% rate hike in a row (June and July). I believe The Federal Reserve feels guilty for letting inflation get out of hand and not responding quickly enough, so they are taking aggressive action now and signaling that they will continue to do so until they see improvement. Inflation resulted in less reduction than was hoped for by markets in September. So, the Fed is not resting on the hope that inflation will come down on its own; instead, they are taking aggressive action to force it down. They have decided to proactively fight it in the form of higher rates by year-end nearing 4.3% (another roughly 1-1.25% increase from where we are now).
Policy adjustments need to happen with an eye toward future economic conditions, not current ones. The FED action in September is aggressive enough that if we continue along their anticipated path, it suggests there could be trouble for the economy ahead. It is likely that this intensified upward push will start to slow the economy, sending us into a recession, or what many are calling a hard landing now. This is why markets reacted so strongly to the downside for the last half of September.
Inflation
Inflation is starting to come down, and it is just not coming down as fast as the Federal Reserve (not to mention consumers) would like. Gasoline prices have continued their downward trend since peaking in June of this year. While that has helped curtail inflation, it is a lagging effect. Housing prices and food are the most troublesome components now. With mortgage rates catapulting to the 7% range on a 30-year fixed market, many people are getting priced out of the housing market. This means housing prices will likely start to decline, meaning less pressure on inflation in the coming months. Check out the video portion of our commentary for more in-depth information!
Bonds, Certificates of Deposits, and Treasuries are in style again!
Just as equities have experienced a tough year, bonds have also shared their own headwinds. With interest rates increasing rapidly this year, bond prices have come down and affected performance. But bond yields are finally paying some pretty attractive rates, and the yield on bond holdings is rising. Some might ask: "If rates are up, why is my brick-and-mortar savings account still yielding only .13% on average?” Banks are slow to adjust the interest they are paying because they have ample cash on hand to lend out (not to mention borrowing has all but dried up at these higher rates). So they do not need to pay you higher rates to attract you to deposit more money.
Russia
For the moment, there is a lot of uncertainty in Europe from the Russia/Ukraine conflict. Putin is a wild card, as we do not know when and how he will strike out on any given day. It seems like he should gradually be getting weaker, but we do not know how long this conflict will continue. If there is a policy change or leadership change in Russia, international markets could be in a much better situation.
Strength of the U.S. Dollar
High inflation and high-interest rates to fight the high inflation have strengthened the U.S. Dollar versus most other currencies worldwide. Our strong currency means importing goods from the rest of the world is cheaper. However, there are drawbacks to a stronger currency for companies that source revenue from overseas. On-shoring the profits from foreign currencies back to the U.S. dollar acts as a tax (on top of the new minimum tax rate imposed recently by the administration) to the corporation that must do so, meaning less profits. Following is a chart of how much the U.S. dollar has strengthened this year versus the Yen, Pound, and Euro.
Source: Raymond James
Recession Fears
Still, no one has officially declared that the U.S. is in a recession. Two-quarters of negative GDP (both of which happened in the first and second quarters this year) is the traditional definition of a recession. Politics and mid-term elections coming up will impact whether or not we will hear recession rhetoric out of Washington, but the definition is pretty clear. The National Bureau of Economic Research officially calls a recession here in the U.S. It weighs jobs, manufacturing, and real incomes when assessing whether or not we are in a recession and not just real GDP, so this is important information to watch.
What if we are in a recession?
The average drawdown for the S&P 500 for past mild/moderate recessions (as opposed to severe recessions in the statistic above) has been 24%, which is almost exactly where we ended the quarter.
We also had already hit this level in mid-June before the recovery experienced through the remainder of the summer. Leading into this year's drawdown, we took several actions in portfolios, including rebalancing (since equities had such a strong run in the second half of 2020 and 2021), adding a real asset strategy to help hedge potential inflation, and shortened duration on the bond portfolio. If cash was needed in the coming 12 months, it was raised.
Staying calm in the face of daily market volatility is not always easy. That is why we are here to help. If you are anxious, never hesitate to contact us with your questions!
Angela Palacios, CFP®, AIF®, is a partner and Director of Investments at Center for Financial Planning, Inc.® She chairs The Center Investment Committee and pens a quarterly Investment Commentary.
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