The Stock Market
How bad has this year been? Awful is the only adjective to describe 2022. Data from Evercore ISI shows that 2022 is the only year on record in which the S&P 500 and the bond market have fallen 10% or more. So far in 2022, the S&P 500 has recorded 81 daily moves of at least 1% in both directions as of September 7th, making it one of the most volatile years since 2000. The second half of the year promises more of the same volatility as investors remain uncertain whether the U.S. is in a recession, not in one, or going into one in 2023.
Past Three Months
This summer, we have seen equities attempt to rally twice in anticipation of a potential Fed easing. Both attempts were unsustainable. After the terrible June swoon, the market roared back in July to its best month since November 2020. The DOW climbed 2,069 points, bringing the year-to-date loss down to 8.6%. The S&P 500 climbed 9.1%, and the tech-heavy Nasdaq gained 12.39%. (Data from Cashdollar and Associates) Early September also witnessed a brief rally before running out of steam.
July gains were based on the belief that the Fed would not be as aggressive in raising rates at their September meeting. Signs of an economic slowdown were beginning to be seen. Housing was slowing down rapidly due to higher mortgage rates. The Baltic Dry Index, which is measured in cargo being shipped, pointed to a "getting back to normal" scenario from the severe container backlogs at U.S. ports. The price of shipping a container from China to the west coast of the U.S. has fallen by 70% year over year. However, the cost is still 2.5X its average over the past five years before COVID, as Paul Broughton of Advisor Capital Management reported. Signs of slowing down raised hopes that the Fed would lighten up on rate increases for the remainder of the year.
The Federal Reserve
Unfortunately, Fed Chairman Jerome Powell destroyed any thought of a softening Fed position when he commented during a meeting in Jackson Hole in late August. In a noticeably short speech, Powell wanted to assure investors that curbing inflation would be the Fed's top priority during its September meeting. His extremely bearish speech resulted in a market meltdown of 1,000 points later that day. Over the Labor Day period following his talk, the market fell seven consecutive trading days, its longest slump since November 2016, Barron's reports. Over that period, the S&P 500 retreated 7% and the Nasdaq retreated 9%, respectively, bringing investors to a technical bear market of a 20% selloff. Following his speech, the all-important CPI number was announced in early September. The report showed a renewed rise in U.S. core inflation in August, meaning inflation will persist, forcing the Fed to more aggressive tightening. This leads to the question. Is the Fed responsible for runaway inflation? Last year, the Fed continually spoke about inflation being "TRANSITORY." Only in late November did they drop that word from their prepared remarks regarding inflation and the economy. Now they are trying to catch up by raising rates as fast as possible, reacting to the possibility that they erred in keeping an "accommodating" Fed far too long last year.
One good news is that inflation now seems to be in check and not moving higher. When it begins to retreat is still the unknown.
Blackrock, the world's largest asset manager, in their weekly commentary on September 19th, points to more pain in equities as we move into the 4th quarter. They report that business activity is stalling in the U.S. and Europe. Yet, the Fed is expected to hike rates aggressively to fight inflation, confirming why they do not forecast a "soft landing" for the economy. Unfortunately, they predict a policy of overtightening, which will likely cause a recession. The combination of an imminent recession and higher rates is still not reflected in equity valuations. The Fed's determination to get inflation down to 2% without recognizing the extent of the contraction necessary to do so makes a "soft landing" improbable, Blackrock reports. They believe that the economic damage caused by higher rates and the energy crunch in Europe will be the catalyst for the Fed to stop raising rates.
A well-known investor with a more "bullish" view is Bill Ackerman, founder of Pershing Square. He said, "price pressures will come down a lot, and stocks will rebound soon." One sign of slowing demand comes from China, where exports in August rose 7.1%, well below expectations.
Oil has witnessed a sharp pullback in prices. The U.S. benchmark oil price fell to the lowest since January 26th, trading around $85 a barrel, a significant retreat from the highs following the Russian invasion of Ukraine. Lower oil prices reflect fears of a rapidly cooling global economy. However, a large deficit is expected as colder weather begins, and Russian gas supplies, now cut off from Europe, may cause an increase in gas to oil substitution, causing oil prices to rise again this winter.
The Fed has announced that its number one goal is the reduction of inflation. Those remarks will likely witness the continued upward climb of interest rates, forcing Treasury yields higher. On September 21st the fed confirmed the expected 75 bp rate hike. According to CME Group, there might be another 125 bps of expected rate increases by the end of this year. Higher rates may support the inverted yield curve, where short-term rates yield higher than longer-dated maturities. Currently, we are near a 50 bp spread between the 2-year and 10-year treasury. Equity contractions during past bear markets have usually been accompanied by fixed income strength, making for a diversifier for investors. This year that has not been the case, as stocks and bonds are suffering as the Fed tries to contain inflation. The 2 Year Treasury Rate is at 4.02%, compared to 0.22% last year; this is higher than the long-term average of 3.14%. The RMR Investment Committee, with over 35 years of investment experience, has weathered numerous financial storms. We closely monitor events as they occur and prudently make changes in our models when we believe change is necessary acting when opportunities arise, as they often do, during turbulent financial times. Please feel free to contact your advisor with any questions you may have.