Market Perspectives - Economic and Market Update

November 2022

  • The third quarter of 2022 saw ongoing significant declines in both the equity and fixed income markets around the world. Interest rates have continued their parabolic move higher with the impact being felt widely.
  • Dramatic interest rate hikes are now beginning to impact many parts of the economy. Federal Reserve (the “Fed”) policy remains aggressively hawkish to try to break the back of inflation and prevent a longer inflationary cycle. 
  • Notable moves have also been seen in currency markets with the U.S. dollar having strengthened greatly against most of its peers.
  • Slower economic growth is beginning to occur, which may ironically be exactly what is needed in order for the Fed to achieve the reduction in inflation and thereby reach the conclusion of the hiking cycle.
 

“Patience is one of the most valuable attributes in investing.”
- Martin Zweig

 

Market Summary

The third quarter began with stocks and bonds at oversold levels due to the Fed’s announcement in June that it was expecting to increase interest rates by 0.75% in July instead of the anticipated 0.50%. Soon after the announcement, the market began a strong recovery that continued until August 15. This reflected investor optimism that peak inflation was behind us and that the Fed would ultimately pause rate hikes and allow time for their prior actions to take effect. Normally, Fed actions take as long as a year to percolate through the economy. 

However, it quickly became clear that the market’s optimism would be short-lived as a hawkish, laser-focused Fed became even more restrictive after stronger than expected inflation data was reported in subsequent months. Further Fed commentary cemented this hawkish view and culminated in Chairman Powell speaking at the annual Jackson Hole conference. The “higher for longer” view became clear as the Fed signaled it would get to highly restrictive monetary policy territory and sit at those levels for longer than expected in order to crush inflation. 

Since its surprise announcement in June, the Fed has increased rates 0.75% twice more and very recently signaled increasing another 1.00 – 1.25% of rate hikes over the two remaining meetings of 2022, with the first 75 bps likely coming in November. With employment conditions still strong (thus satisfying one of the two Fed mandates), monetary policy would have room to tighten rates more to attack inflationary forces. 

The Fed’s steadfastness in driving inflation lower erased the gain in the first half of the third quarter and sent stocks and bonds lower.  The S&P 500 closed Q3 down almost 25% on the year which was one of the worst starts to a year in history. The U.S. Bloomberg Barclays Aggregate Bond Index (which can be thought of as the S&P 500 of bonds) is down close to 15% year-to-date.

As we assess the current investment landscape, we can’t help but notice the opportunities that have been presented. Stocks are much less expensive relative to profits vs. last year, and short-term, risk-free bonds (short-dated Treasuries) finally have reached attractive risk/return levels.
 

Equity Market Update

Stocks around the world suffered another challenging quarter, with all major indices/sectors posting significant losses (other than small-cap growth, which managed a small gain).

Equity Market Update
 

Bond Market Update

The fixed income markets have fared poorly as well with a large drawdown for bonds, particularly those with longer duration. Longer dated treasury bonds are now down nearly 30% on the year.

Bond Market Update
 

Treasury Curve 2022 vs. 2021

Over the last year, interest rates across all maturities have moved significantly higher, with shorter-term rates moving far more than longer-term rates. In general, this has created a more attractive yield environment for investors following many years of extremely low rates.

Treasury Curve
 

Mortgage Rates at Levels Not Seen Since Before 2005

Higher mortgage rates will make home affordability more challenging. 

Mortgage Rates
 

Housing Market May Be Showing Signs of Weakness

The NAHB/Wells Fargo Housing Market Index (HMI) is based on a monthly survey of NAHB members designed to take the pulse of the single-family housing market. The survey asks respondents to rate market conditions for the sale of new homes at the present time and in the next six months, as well as the traffic of prospective buyers of new homes. The survey shows that higher mortgage rates are beginning to impact the housing market. 

Housing Market
 

Consumer Price Index (“CPI”) Has Fallen from Recent Peak

Inflation readings remain elevated, and this trend has and may continue to persist as items such as rental income and wages remain elevated. 

Customer Price Index
 

Oil Prices Have Fallen Since the Peak in March

The drop in energy prices may be easing inflation pressures and the burden on consumers. 

Oil Prices
 

Fed Policy Has Become Restrictive as Inflation Remains Above Target

The labor markets remain strong, in line with the Fed’s mandate. Inflation levels are far above mandate levels, forcing the Fed to act to stem price increases of goods and services in the real economy.

Inflation
 

Fed Funds Futures Market Expectations

While Fed Funds futures imply further rate hikes are coming, markets are projecting an end to the hiking cycle in the first half of 2023. If these projections prove accurate, fixed income markets may begin to stabilize.  

Fed Funds
 

Valuations Have Dropped to Levels Below 20-Year Averages

Average P/E multiples, a commonly used method to value companies, are now below average in many areas of the market. From December 2021 to September 2022, P/E multiples have fallen dramatically when compared to their 20-year averages. 

September 2022
December 2021
 

The U.S. Dollar is at Multi-Decade Highs vs. Peers  

The restrictive actions of the Fed vs. central banks around the world are strengthening the U.S. dollar and challenging U.S.-based multi-national corporate profits. Additionally, this can be a boon for U.S. consumers, as a stronger currency enables consumers to purchase more foreign goods.

ICE US Dollars Index
 

Bond Market Yields

Dramatic rate increases have led to more attractive income streams for fixed income investors.

Bond Market Yields
 

Summary

  • Financial market declines thus far have not been accompanied by significant economic weakness. Labor markets remain strong, providing the Fed with more room for the path of restrictive monetary policy.  
  • This has provided a more attractive fixed income environment for investors, particularly at the shorter, less volatile end of the bond market.
  • As investors monitor economic conditions for signs of a turn, markets may be entering the “bad news is good news” phase in which weaker jobs growth, slower economic growth, and a generally slowing economy may cause the Fed to pause the hike cycle, thereby calming markets around the globe. Third quarter corporate earnings releases could also reinforce some of the recent challenges. We are closely monitoring such developments.
 
As we enter fall and head rapidly towards another year end, our process remains disciplined and focused on the long term. A balanced, rational perspective is typically a winning strategy. We leave you with another great quote from an investing legend:
 

“The intelligent investor is a realist who sells to optimists and buys from pessimists.”
– Benjamin Graham


Please reach out to your BDO Wealth Advisor with any questions.