Wealth Matters Newsletter - October 2022

Fall is my favorite time of year.  Cooler temperatures, changing leaves, and the season’s sports are a few of the things that I look forward to after the dog days of summer.  For investors though, fall’s beginning has historically been a less-than-stellar period for investment returns and this September certainly lived up to the historical experience.  Tough talk on inflation from the Federal Reserve (Fed) in August and indications of interest rates heading higher for longer following their meeting in September were primary contributors to the slide experienced by stocks and bonds through the end of the quarter.  

Markets moved higher for the first half of the third quarter, as lower energy prices spurred hopes that the Fed would not need to raise rates as much as had been previously forecast.  Fed Chair Powell cast those hopes aside at the Fed’s Jackson Hole Economic Symposium, where his comments unmistakably reaffirmed the Fed’s priority of bringing inflation down.  Downside momentum continued in September, where the Fed raised the Fed Funds Rate by 0.75% for the third consecutive time this year.  While the rate hike was largely expected by investors, what was not priced in was the shift in the Federal Open Market Committee participants’ assessment of how high rates may need to be raised. See the table below from FHN Financial illustrating the change in the dot plot from June to the September meeting.

As the table shows, the median Fed Funds rate peak of 4.6% in 2023 is significantly higher than that which was anticipated in June of this year.  It was this movement up in anticipated rate increases over the next several months that led to more selling in the latter half of September. These new forecasts, along with a surprise rate hike from the Swedish central bank, dovish fiscal policy from the United Kingdom, and unrelenting U.S. dollar strength cast a shadow over markets as the quarter ended.  See the following table for major market index returns at the end of the quarter.

Considering the direction and level of interest rates and the impact of foreign currency translation, earnings estimates for 2023 of the S&P 500 may be too high.  With U.S. Dollar Index near 20-year highs, companies that generate revenue from foreign sources will be negatively impacted by foreign currency translation (foreign sales converted to few U.S. dollars).  The U.S. dollar’s strength is attributable to the its status as a reserve currency and the relatively high level of interest rates here in the U.S. versus other developed economies, amongst other factors.  If earnings estimates are too high, then perhaps the action in the stock market is warranted at present.  When third-quarter earnings announcements begin in a couple of weeks, profit warnings or lowered earnings guidance for future quarters could push stock prices lower.  Consumption has remained strong and the labor market tight, which may provide some support to earnings in the near term.  However, if inflation remains stubbornly high, and the Fed continues on its current policy trajectory, it will be difficult for both of these supportive conditions to remain intact.

Globally, there are numerous factors feeding the negative sentiment loop.  Certainly, the war in Ukraine and its destabilizing effects on the region are well-publicized.  From food and energy to currencies, there is a palpable amount of stress that is leading growth to slow in most of the industrialized world.  China, too, is experiencing its own economic hardship, as its real estate market endures weakness not witnessed in years.  Real estate is a primary economic engine in China; the zero-COVID policies enacted by its central government have caused substantial stress in the real estate market, including the specter of deflation.  Needless to say, there is plenty of doom and gloom for the media to peddle.

The bright side?  Sentiment is very bearish.  Often when there is so much negativity and bearishness in the market, opportunities for a rally begin to appear.  In a year where stocks and bonds have sold off, I am seeing opportunities in bonds that we haven’t seen in over a decade.  As an example, for much of the last decade, U.S. Treasury investments offered very little in the way of compelling return opportunities; now, we are seeing rates and yields that offer real competition to stocks.

I share this information with you not to scare, but provide some context to the complexity of the financial world in which we live.  At times like these, it is very easy to lose sight of long-term goals amid short-term events.  We have spoken time and again about the dangers of letting emotional decisions upend sound, thoughtful, long-term plans.  We are here to help you navigate these challenging times and encourage you to reach out with any questions or concerns.