Uncertainty regarding the course of inflation, interest rates, and economic growth have raised havoc in the markets. Stocks and bonds delivered a third consecutive negative quarter for 2022 (see attached Q3 Quarterly Market Review). The S&P 500 (1) drawdown through the end of Q3 was -23.87%. From a historical perspective, a ~24% drawdown is consistent with past recession selloffs triggered by a fed policy normalization. Though one can’t be sure that a bottom is in, especially as the Fed stubbornly continues its tightening path, the market is likely in the vicinity of a bottom. Trying to divine the precise bottom of a stock market drawdown to time an investment is foolhardy. Therefore, long-term investors should view this market drop as an opportunity to put money to work in stocks. The paradox of investing is that it’s best to invest when it feels the worst!
The Federal Reserve is culpable for leaving emergency measures in place for too long. They ignored a rapidly tightening labor market and discounted the risk of persistent inflation. That policy misstep cost them credibility. To restore credibility, the Fed is overcompensating and must become super hawkish in its words and deeds. Interestingly, the Fed has committed to tightening to the point of killing the jobs its prior policy was trying to protect! The rate hikes administered thus far appear to be taking a bite out of inflation; however, continued aggressive tightening may cause an unintended breakage of economic or market functioning here and abroad. Fed policy reversals are far from unheard of, and should it become evident that the Fed’s stance is doing more harm than good, the Fed may be forced to back away from its beat inflation at any cost stance. Unfortunately, the way it’s measured, meaningful progress on reigning in inflation won’t be known until after the fact. The federal reserve is committed to being very confident inflation has been brought to heel. And the risk remains that they will damage the economy more than necessary.
The good news is that there is growing evidence the tide has turned for the war on inflation. Several data points support the assertion that price declines are nigh. The clearer signals of lower prices come from the commodities (oil, lumber) and retail sectors (goods prices pressured by inventory issues). Higher mortgage rates have hit the housing sector as input prices like lumber, builders, and buyer activity are cooling fast. The labor market appears to be loosening up as well. The October 4th Job Openings and Labor Turnover (JOLTS) report showed “Job Openings Plunged” by More Than 1.1 million in August.” Historically reliable market-based inflation indicators reflect lowering inflation expectations anchored to levels consistent with the Fed’s target inflation rate. These factors bode well for an accelerating decline from the current 8% headline CPI rates over the next two quarters. Confirmation that inflation has peaked should cheer markets and give the Fed some much-needed street cred and, perhaps, patience to give the policy medicine time to work.
The increase in bond and money market yields marks the end of a four-decade investment era characterized by declining inflation and interest rates. Depositors and bondholders are getting higher yields; however, investors should avoid getting lured into a false sense of security about a 3-4% yield. Yes, it’s an improvement, and bonds still have desirable diversifying attributes. But real return (return in excess of inflation) is what builds long-term wealth, and stocks are the undisputed asset class champion for long-term investors seeking to build real wealth.
As the Fed remains strident, markets will stay volatile in the near term. However, improving CPI reports and an inevitable Fed policy change will likely bring a sustainable stock recovery. Stocks look forward, and the first moves up are often the biggest when they sniff out better days ahead. If you have investable cash, consider committing it to long-term investments. Other appropriate actions may include maxing out retirement plan contributions or doing a Roth conversion.
Don’t assume a short-term drawdown of your financial accounts will knock your retirement plan off track. Instead, let us revisit your financial plan and review your portfolio with you. Doing so can help you reframe your unique personal financial goals and circumstances into a long-term view. This is the best way to assess the impact of market changes upon achieving your goals and provides a framework to consider corrective actions if warranted.
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1. S&P 500 Index – The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general.