As we stated a few weeks ago in our September 2022 Stock Market Update, inflation continues to be the primary reason the stock and bond markets have experienced such a dramatic downturn this year. After a two-month rally of 17% from mid-June to mid-August, the S&P 500 Index declined to its low for the year at the end of September. The S&P 500 Index ended the third quarter down 5.3% for the three-month period and down 24.2% year-to-date. The Dow Jones Industrial Average and NASDAQ Composite suffered similar fates, down 6.2% and 3.9% for the quarter, respectively.
During typical market declines, investors buy high quality bonds for safety, thus driving down interest rates and boosting the performance of fixed income investments. However, this year has been anything but typical in the bond markets as the Federal Reserve has dramatically increased interest rates. The Bloomberg US Aggregate Bond Index, a broad index of intermediate term investment grade bonds and the primary proxy used by investors to track the performance of the bond market, declined 4.75% during the third quarter and is now down 14.8% this year. The weak bond market has contributed to the worst year for the traditional portfolio of 60% stocks and 40% bonds since the 1930s. To quantify the magnitude of the interest rate increase this year, the yield on the 10 Year US Treasury Note has more than doubled from 1.51% at the end of 2021 to 3.81% as of September 30th.
There were several headline factors that contributed to the declining market in September:
- The August Consumer Price Index (CPI) report released on September 13th showed headline inflation increased 0.1% for the month and 8.3% over the past year, while the core CPI figure excluding food and energy rose 0.6% for the month and 6.3% over the past twelve months. Both readings were above analyst expectations.
- A profit warning from FedEx on September 15th citing weak demand in global shipments signaling a significant decline in worldwide economic conditions.
- An increasingly hawkish statement from the Federal Reserve that accompanied its interest rate increase of 0.75% on September 21st. Fed Chairman Powell stated, “The FOMC is strongly resolved to bring inflation down to 2%, and we will keep at it until the job is done.”
- A US dollar that continues to strengthen, which pressures the earnings of large multinational US corporations.
- Projected earnings per share for the S&P 500 index were revised lower during the quarter from 10.5% year-over-year as of June 30th to 2.9% as of quarter end.
The focus of investors as we enter the fourth quarter is on key inflation readings as well as third quarter corporate earnings announcements. The September CPI figures will be released on Thursday October 13th, followed by numerous large financial institutions earnings reports the following day. As we noted above, analysts expect S&P 500 earnings to increase only 2.9% year-over-year for the third quarter, but the market will be listening closely to commentary from corporate executives.
The Federal Reserve has said they plan on continuing to raise interest rates, and the market expects another 0.75% rate hike when the Fed meets on November 2nd. The Fed will have one last 2022 meeting on December 13th and 14th when it is expected to raise rates another 0.50%. Central banks around the world are all facing the same challenges of global supply chain problems, higher energy prices, the war in Ukraine, and tight labor markets, all causing an increase in inflation. But one of the key worries of many market participants is that central banks around the world are raising rates too fast to understand the impact on the economy of their previous rate hikes. The risk is the economy could be thrown into a deep recession. Unfortunately, currently there are few signs that central banks plan on pausing to assess the impact of their rate increases.
There has been some recent positive news on inflation outside of headline CPI numbers. Richard Galanti, Chief Financial Officer of Costco Wholesale Corporation recently said on their September 22nd earnings conference call, “We’re seeing commodities – some commodities prices coming down, such as gas, steel, beef, relative to a year ago, even some small cost changes in plastics. We’re seeing some relief on container pricing. Wages are still the higher thing when we talk to our suppliers…But overall, some beginnings of some light at the end of the tunnel.” Beyond his comments, lumber prices have fallen to their lowest level in more than two years, bringing their prices back to the level where they were before the pandemic began.
The Fed’s continued hawkish stance in the face of deteriorating economic conditions is now drawing the ire of some market commentators. Jeremy Siegel, Emeritus Professor of Finance at The Wharton School of the University of Pennsylvania, along with many other market pundits, have said that when commodity prices and housing prices were booming a year ago the Federal Reserve should have started raising interest rates. Instead, the Fed insisted that inflation was transitory and kept monetary policy in ultra-accommodative territory. Dr. Siegel commented, “It seems to me wrong for Powell to say we’re going to crush wage increases, we’re going to crush the worker, when that is not the cause of inflation. The cause of inflation was excessive monetary accommodation for the last two years.” According to Dr. Siegel, “The Fed had the wrong policy when inflation was raging and they have the wrong policy now, as inflation is subsiding and even reversing into declines. I see no reason for the Fed to be as tight as it suggests it needs to be towards the end of 2023…I still believe stocks will be the asset of choice for long-term investors.”
Here is some interesting stock market historical data that could bode well for a better market over the next year:
- Mutual fund company, Hartford, calculated the average bear market since 1929 has lasted about nine and a half months. The market highs were at the beginning of this year, so we are right on that average now.
- Brokerage firm, Edward Jones, calculated that of the five most recent transitions out of bear markets, the S&P 500 rallied an average of 25% during the first three months of these new bull markets. Additionally, around one-third of a bull market’s very biggest daily gains occur during the first two months of a new bull market.
- The fourth quarter of midterm election years and the first quarter of the third year of a presidential term have historically been the two strongest quarters of the 16-quarter presidential cycle, according to CFRA research.
- Historically, the stock market has done very well in the year following midterm elections. The Capital Group stated that the average annual return for the S&P 500 was 15.1% for the year after midterm elections compared with 7.1% for all other years.
- The S&P 500 has moved higher in the one-year period following every midterm election since 1942, according to Dow Jones Market Data.
- Ryan Detrick, chief market strategist for Carson Group, reviewed the stock market’s historical performance under different party compositions in Washington DC. He found that the most advantageous combination was a Democratic President with a Republican congress. In that scenario, the S&P 500 produced an annual return of 16.3% the year following the election. A Democrat president with a split congress yielded a 13.6% return.
- No one can predict when a bear market will end. Similar to Hartford’s research, Ned Davis Research calculated the average bear market lasts about 10 months with an average decline of about 36%. The bull market makes up for accepting this volatility with an average gain of 112%. Ned Davis Research summed it up this way, “So, over the long term, the absolute risk investors face is not the next 36% decline in a bear market. Instead, it’s missing out on the next 112% bull market gain.”
Our opinion from a few weeks ago still applies. We know long bouts of stock market turbulence like we have experienced so far this year can be stressful and emotional, but if you can ignore the noise and the markets daily moves, you will be rewarded in the long run. As legendary money manager Peter Lynch reminds us, “the secret to making money in stocks is not to get scared out of them.” Please let us know if you have any questions or if you would like to discuss your financial situation in detail. Thank you for being clients of our firm.
Marietta Wealth Management, LLC
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