The third quarter of 2022 started off with a great deal of optimism. Inflation appeared to begin flattening out with July’s CPI (Consumer Price Index) showing some moderation in price pressure. Additionally, the 2-year Treasury, a good bellwether of future interest rate hikes, stabilized and investors’ confidence began to grow. The market took off from June’s lows and recovered almost 40% of its year-to-date losses by the middle of August. Ultimately, this impressive move turned out to be a typical bear market rally, and from late August to the end of the quarter the S&P 500 declined -15%, bringing the year-to-date loss to -23.9%, closing on the lowest level of 2022 on September 30th. The technology-heavy NASDAQ, S&P Mid-Cap and Small-Cap indexes saw an even greater decline and growth stocks widely underperformed their value counterparts. Just one sector of our domestic economy – energy – was positive for the year. Overall, the stock market had its worst start to a calendar year since 2002.
The Bloomberg Barclays U.S. Aggregate Bond Index, which acts as a proxy for the investment-grade bond market, also decreased in the quarter, bringing the year-to-date decline to -15.6%. It was by far the worst start to a calendar year since the Index was introduced in 1976. This negative performance was mostly caused by an increase in interest rates. The yield on the 10-year Treasury note rose to 3.83% while the 2-year note was yielding 4.25%, thus inverting the yield curve.
This dramatic turn in the behavior of the market was ignited by Federal Reserve Chair Jerome Powell’s comments at the Jackson Hole conference on August 26th, when he dismissed the idea of a looming Fed pivot to less aggressive monetary policy. Moreover, he bluntly warned that the U.S. economy will likely feel some “pain” from the Fed’s actions, diminishing the hopes for an upcoming end to the rate hike cycles. Typically, the Fed is focused on balancing maximum employment and stable prices. However, over the summer it became clear that inflation would not be tamed so easily. The Consumer Price Index climb of 9.1% year-over-year for the month of June was the highest since November 1981, and, though it backed off slightly after that peak, it remains stubbornly high. In response, the Fed is putting more weight on bringing inflation down, and thus far in 2022, the Federal Open Market Committee raised interest rates by a total of 3%, the largest calendar year increase since the 1980s.
Our domestic economy has slowed down from the historically high growth rates of 2021. The -.06% drop in GDP in Q2, following the -1.6% decline in the previous quarter met the technical definition of a recession. Still, it is important to remember that the National Bureau for Economic Research, a widely accepted arbiter for the health of the U.S. economy, employs a broader definition, classifying a recession as “a significant decline in economic activity spread across the country”. Based on this definition we have yet to see clear signs that a recession has arrived. The Purchasing Managers Index, which measures economic activity in both the manufacturing and service sectors, increased in September, the Consumer Confidence Index increased to a five-month high during the same period, and, most importantly, the job market remains strong with over 3.5 million net new jobs created so far this year. So, while the economy is undoubtedly slowing, one may still expect a soft landing as opposed to a prolonged recession.
As we start the final quarter of 2022, concerns regarding a slowing economy have increased. Rising interest rates will be a headwind for corporate profit and have the potential to negatively impact corporate spending. Heightened geopolitical tension could lead to continued energy shortages. Tight monetary policy can cause a recession. Yet, when it comes to the stock market, it is important to remember that stocks are a long-term investment. Moreover, this headwind reality shall be viewed in the context of a market which has already priced in a lot of negative news and declined substantially. This decline has brought the valuation back closer to pre-Covid levels and multiple sentiment indicators are quickly approaching levels historically defined as extremely pessimistic and bearish, pointing to a possible market bottoming. And while there is still risk of further downside and volatility, history tells us that throughout periods of similar macroeconomic turmoil, the markets will eventually recoup any losses and move to meaningful new highs. There is no reason to think this time will be any different.
Dumont & Blake Investment Advisors, LLC
September 30, 2022