Quarterly Review & Outlook
In the third quarter of 2022, the S&P 500’s bear market clocked in at ten months old, the Federal Reserve continued to tighten monetary policy as inflation accelerated, and recession predictions filled news headlines. With stocks and bonds down more than 25% and 15%, respectively, so far this year, 2022 is shaping up to be one of the more painful years in recent memory. But these down markets, although they feel treacherous, present disciplined investors with tremendous opportunities for long-term growth opportunities. With stocks and bonds down more than 25% and 15%, respectively, so far this year—2022 is shaping up to be one of the more painful years in recent memory. But more importantly, it’s evolving into one of the most attractive opportunities we’ve seen in decades.
Market Review Q3’22 Returns
Past performance is not a reliable indicator of current or future results. Indexes are unmanaged and not subject to fees. It is not possible to invest directly in an index. Note: views are from a U.S. dollar perspective. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast or guarantee of future results. Source: Kestra Investment Management with data from FactSet. Index proxies: Bloomberg U.S. Aggregate Bond Index, ICE BofA U.S. Corporate, ICE BofA U.S. High Yield, S&P 500, MSCI EM, MSCI EAFE, Dow Jones U.S. Select REIT, Bloomberg Commodity Index. Data as of September 30, 2022.
How Did We Get Here?
For nearly two years, the Federal Reserve and federal government fought the economic effects of COVID through extremely loose monetary and fiscal policy. With that, inflation began to grow, and by early 2022, the Fed began tightening monetary policy. Two issues complicated an already difficult job:
Russia’s invasion of Ukraine sent commodity prices, such as oil, natural gas and wheat, soaring and heightened geopolitical risks. While many of those prices have since retreated, war continues.
Price increases proliferated elsewhere in the economy, driving wages rapidly higher
With the Fed hyper-focused on taming inflation, the markets are keenly following any sign of inflation abating. While there have been reasons for optimism, such as falling shipping prices, climbing inventories, or lower commodity prices—the Fed still faces an uphill battle with consumer prices climbing by nearly 9% year over year, the biggest change since 1981.
Where Do We Go Next?
With the possibility of a recession on everyone’s mind, we monitor two key indicators that have proven to be reliable signals of a looming recession: the treasury yield curve and the ISM manufacturing index. As discussed in our last Markets in a Minute, these indicators point to a growing likelihood that we’ll experience a recession within the next year. And where recession risks abound, market volatility surely follows.
Economic Dashboard
While the Fed is working to tamp down economic activity, some areas remain resilient. For instance, jobs remain plentiful, and the consumer has grown more optimistic. But home prices, which tend to be very sensitive to interest rates, are falling rapidly in some markets, and manufacturing is slowing.
Source: Kestra Investment Management
We will watch for two signs that could suggest we’re nearing the end of this bear market:
A meaningful decline in earnings expectations for 2023 – analysts estimate that earnings for the S&P 500 will grow by 10% next year. Given our expectation of a recession, those estimates appear too rosy.
Clear evidence that inflation is slowing, particularly with wages – while there are some early signs of slowing price increases, wages remain sticky, and the labor market is extremely tight. The Fed will likely need to see some abatement in wage inflation in order to declare the inflation war won.
Source: Kestra Investment Management and Compound Capital Advisors. Data as of August 11, 2022.
What Should Investors Do?
With equity and fixed-income markets already down significantly this year, much of the economic slowing appears priced in. Remember that stock and bond prices today reflect what’s expected in the future. While we expect more economic softening ahead, markets tend to rebound well before the economy does, and sometimes even before we officially know that we’re in recession.
Some strategies that investors may want to consider taking advantage of volatile markets:
· Dollar cost averaging
· Portfolio tune-up
· Tax-loss harvesting
Outside the New York Stock Exchange, there’s an iconic statue of a bull to symbolize the long-term upward trend of stocks. Bear markets play just as much of a role in the history of the stock market. In fact, the bear markets, when prices are depressed, can provide attractive opportunities for the disciplined investor with a dose of courage and a long-term time horizon. While stocks don’t always go up, every bear market we’ve experienced so far has eventually been followed by a bull.