While it may seem like a distant memory, Q3 started with optimism. We saw (potential) signs of inflation slowing, solid corporate earnings, and expectations that interest rate hikes might end sooner than later. But beyond mid-August, that optimism was eroded by sticky inflation data, geopolitical concerns, and Chairman Powell suggesting more “pain” was to come.
So as the market seeks more clarity, we are still trading around similar lows that we saw back in June. Let’s see how some of the major market components did in Q3, as well as the 1 and 3-year annualized returns:
|S&P 500 Large Cap Index
|S&P Small Cap 600 Index
|S&P Developed BMI International Index
|S&P U.S. Aggregate Bond Index (total return)
|S&P Municipal Bond Index (total return)
|Dow Jones Equity All REIT Index
|Dow Jones Commodity Index (total return)
SOURCE: DOW JONES, DATA AS/OF 9-30-2022 (DOESN’T INCLUDE DIVIDENDS UNLESS NOTED). HERE IS A COMPREHENSIVE LIST OF RETURNS.
Looking back, here are some observations.
Over the summer, we saw a nice relief rally (up nearly 15%) but it quickly faded. Here’s the 3-month chart showing the roller coaster-like performance:
When stocks are down, we often times look to bonds for support. But bonds have been no safe harbor this year since rising rates tend to push bond prices lower. Thus, even well-diversified portfolios have seen dismal performance during this unusual sequence of events.
Stock and bond market performance—along with increasingly extreme moves in the currency markets—were volatile. It was driven by the knock-on effects of decades-high inflation, aggressive interest-rate increases by the Fed and other major central banks, and rising risks of a recession. Factor in the lingering ripples from the pandemic and Russia’s invasion of Ukraine, and we’ve seen heightened/consistent volatility.
If we look for the bright spots, the energy sector was positive for the quarter. Same for “consumer cyclical” which are companies like Tesla, Starbucks, and Amazon. Commodities dipped in Q3 but have been solid for the past year or so. The standout in that category was wheat, mainly because the supply of it remains under pressure due to Russia’s aggression in Ukraine.
Developed international markets (Japan, Europe, UK, etc.) moved consistently with the U.S. markets in Q3. China was also lower. China continues to combat declining growth and continued COVID-related lockdowns, which in turn is dragging down overall emerging market returns. Not to mention, a strong US dollar causes other currencies to depreciate, making the world poorer and less able to engage in trade. With the USD having its best run in 20 years, this has caused international markets to look even worse. Even US multinationals – who have sizable sales outside the US – experience slower growth since their products look expensive elsewhere.
In looking at the benchmark for interest rates (the 10-year Treasury bond), it proceeded to march higher. Over the quarter it jumped from 2.97% to a close on 9-30-22 of 3.83%. The silver lining in this increase is that money markets, bonds, and other interest-bearing accounts are finally paying yields that are considered attractive. New home buyers probably are not enthralled however, with the corresponding spike in mortgage rates.
Inflation is still the big buzzword these days, and the Fed continues to use its most potent weapon (raising interest rates) aggressively. They have now hiked rates in March (.25%), May (.50%), June (.75%), July (.75%), and September (.75%). People in the media debate whether or not this is too much, too late, or not enough. Time will tell, but it is considered one of the more aggressive rate hikes in recent memory.
Increasing interest rates to stop inflation is somewhat like treating cancer with chemotherapy. In most cases, chemo can shrink or expunge the disease, but it takes a great toll on the rest of the body. Similarly, increasing interest rates can kill inflation but it causes damage to the economy. And with the market pullback so far in 2022, it appears we are pricing in that damage.
In that context, let’s look back to the last time we encountered some of the inflationary and potentially recessionary economic conditions we’re currently enduring. We now have the compound wisdom to know just how wrong an infamous 1979 BusinessWeek cover story turned out to be when it declared “The Death of Equities.” Eventually, BusinessWeek rolled into Bloomberg’s publications. Forty years later, in 2019, a Bloomberg columnist described how they were “still getting grief” about it:
“Three years after [“The Death of Equities”] appeared, the stock market hit bottom and then began a remarkable resurgence. The total return on the Standard & Poor’s 500-stock index since its 1982 low, with dividends reinvested, has been nearly 7,000%. Not bad for a corpse.”
It would’ve been a bad idea to give up on capital markets in 1979. It remains a bad idea to give up on them today, especially given the compound wisdom we’ve acquired since then. Durable, well-diversified asset allocation remains our best strategy in bull and bear markets alike.
As always, there are a number of things that could prove disruptive or conversely, become a catalyst for a bounce back. One lingering situation is the Russia-Ukraine situation, and we all hope for a peaceful resolution sooner than later. But until then, the risk of Russia using tactical nuclear weapons or sabotaging the Nord Stream pipeline is certainly concerning. Europe is worried about having fuel for heating in the coming winter months – imagine being there!
We recently saw Hurricane Ian reap havoc in Florida and the Carolinas, and there may be a financial fallout from that. Another major event happening soon is the US mid-term elections, and this could shift the balance of power in Congress. If you are like me, you are getting daily mailers and other advertisements of politicians bashing each other. So uncertainty in these areas can influence markets and rates as well.
On the positive side, many analysts point to several internal measures that suggest the stock market is oversold. They say the market may have fallen too far, too quickly. Some say there are signs that inflation has peaked as well. Others point to a strong labor market. And lastly, if there is a recession on the horizon – has this already been anticipated (aka priced in) to the current market prices?
We encourage readers to recall everything we’ve preached to manage your globally diversified mix of stock, bond, and appropriate alternative investments. At TrustTree Financial, we base portfolios on the assumption that markets are durable over the years, and frequently uncertain in real-time. (And yes, as we’re seeing, that can apply to bond markets too.) In general, we encourage several considerations at this time, such as:
- Sticking with your well-planned portfolio mix (reallocating when appropriate for your personal financial goals).
- Periodically rebalancing to stay on target.
- Tax-loss harvesting in your taxable accounts.
- Adding even more investable assets to your portfolio while prices are low (especially if you’ve got a long time to invest).
- Taking a close look at your discretionary spending (especially if you’re in early retirement).
Studies over the decades show that it’s nearly impossible for anyone to pick the exact bottom or exact top of a market cycle. Don’t let the “talking heads” on the TV fool you! And once the market begins to look beyond the current gloomy environment, a well-balanced portfolio will respond nicely. We’ll keep our focus on long-term success, as usual.
Disclaimer: This information contains forward-looking statements about various economic trends and strategies. You are cautioned that such forward-looking statements are subject to significant business, economic and competitive uncertainties and actual results could be materially different. There are no guarantees associated with any forecast and the opinions stated here are subject to change at any time and are the opinion of the advisor. The information should not be construed as legal, tax, nor investment advice. Never make investment or financial decisions based on information provided here, without first consulting with your professional investment advisor. Data comes from the following sources: Census Bureau, Bureau of Labor Statistics, Bureau of Economic Analysis, the Federal Reserve Board, and Dow Jones. Data is taken from sources generally believed to be reliable, but no guarantee is given to its accuracy.