Tyler Silverthorn, CFP®, AIF®, Wealth Advisor
The big story of this year, and the 3rd quarter, is that the Federal Reserve continued to be increasingly hawkish in the face of persistent inflation. After raising rates by 75 bps in June (going further from initial guidance for a 50 bps hike), they raised rates again by 75 bps in July and September. That’s a total of 5 rate hikes between March and September, bringing the Fed Funds target rate to 3.0-3.25%.
At the September meeting the Fed also revised their forward projections. The big surprise (and headwind) for markets was the median Fed target rate rising from a maximum of 3.8% to 4.6% in 2023. Expectations are for another 100-125 bps increases this year alone, at their November and December meetings. It is important to remember that financial markets, especially the bond market, reflect known and anticipated information. That is why when the Fed increases interest rates 75 bps as they previously indicated that they would, you do not see interest rates jump up 75 bps overnight. The market has already accounted for the future rate increase and has priced the increase into the value of assets. The Fed adjusting their projections so frequently and aggressively in 2022 has led the markets to be unable to accurately price-in future rate increases. This has led to huge losses for bonds, and the US Aggregate Bond Index is set to fall for a second consecutive year in a row, with a peak-to—trough drawdown of more than 15% – the worst in its history.
We spent a lot of time writing about inflation because that is what will largely drive the Fed’s decisions, which will have a large impact on the economy. Economic fundamentals remain solid. The labor market remains robust with labor market growth at very high levels. The unemployment rate did rise in August from a very low level, but the reason for the rise was also promising: more people decided to re-enter the labor force. Some companies are starting to scale back hiring and even laying off workers in response to tighter financial conditions ahead. Ironically, for markets, this could be considered good news. A little bit of bad news in the labor market could be good news in the sense it shows Fed policy is having an impact and cooling labor inflation. In the recent Federal Open Market Committee (FOMC) press conference, Powell mentioned his intention to cool labor inflation more than a few times.
Overall, this has been a challenging year for almost all asset classes, Growth stocks have been hit more than twice as hard as value stocks and smaller capitalization stocks are not fairing any better than larger capitalization stocks. International developed and emerging markets are down even more than the U.S.
Midterm years are historically the worst for stocks out of the four-year Presidential cycle. Most of the weakness is usually early in the year, while the fourth quarter is usually strong. Clearly that is playing out again this year, but investors need to know that some of the best times could be right around the corner. Think about this, stocks have never been lower a year after the midterm election going back to WWII. As bad as things have been, selling now might not be wise.
Some of the worst year in market history even had nice bounces in Q4. In fact, the previous 10 worst starts to a year ever saw Q4 higher nine times. Yes, 2008 was the only negative time, but we do not think we are in that type of an environment.
As we enter the fourth quarter, we are likely in the later stages of the U.S. Federal Reserve (Fed) rate hike cycle. However, the Fed is still predicted to hike rates another 1% to 1.25% by year end. Both stock markets and bond markets will likely remain volatile as we continue through this rate hike cycle. However, there are some positives. Earnings estimates have been lowered, creating room for upside surprises, and stock valuations are cheaper. Bonds offer more yield and much of the Fed rate hikes have already been accounted for in bond prices. The last six bull markets began with outsized gains in the first year of the bull market, so that can serve as a reminder to stay invested and diversified across asset classes, sectors, and countries, while adhering to long-term risk and return objectives.
|Barclays Aggregate Bond Index
|Morningstar Moderately Conservative Index
|Morningstar Moderate Index
|Morningstar Moderately Aggressive Index
|Morningstar Aggressive Index
|S&P 500 TR
If you are still looking for more information on the topic please be on the lookout for the recording of Stonebridge’s Market Update. You’ll hear from several members of Stonebridge Team on topics including, but not limited to:
- Updates about the current state of the markets
- How we’re keeping you on track in pursuit of your goals
- The importance of staying the course
- Using this downturn to your advantage
More details will be sent to you surrounding the details of the recording and where you can access it.
The views stated are not necessarily the opinion of Cetera Advisor Networks LLC and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results. Investors cannot invest directly in indexes. The performance of any index is not indicative of the performance of any investment and does not take into account the effects of inflation and the fees and expenses associated with investing. The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.