Market Update: October 1, 2022
In the last several weeks, we have continued to face elevated uncertainty in financial markets due to high inflation and rising interest rates, and we thought it was an important time to take stock. It has been a difficult year, not only for investors but also for households and businesses as we all navigate higher prices and borrowing costs.
Inflation has spiked as a result of many factors: supply chain issues lingering from COVID lockdowns, consumers with lots of cash to spend (partly from government stimulus over the last 2.5 years), and higher energy prices (partly a result of the war in Ukraine). The Federal Reserve (Fed) has responded by increasing interest rates over 2.5% so far this year; they are determined to avoid a repeat of the 1970s, which saw inflation reach double digits and stay there for a while, substantially eroding the purchasing power of American households. However, rather than slowing economic growth just enough to reduce inflation, the Fed typically causes a recession when they raise interest rates. So although we believe they are doing the right thing for the long-term health of the economy, there may be some challenges ahead for the economy as it navigates these higher rates.
This combination of rising interest rates and recession fears has caused both stock and bond prices to drop substantially. Bonds, which often perform well when stocks do poorly, have not provided this protection recently. So where do we go from here?
We do know that inflation is decelerating. Gas and other commodity prices have declined throughout the summer. When our central bankers are sufficiently convinced, the Fed can slow the pace of interest rate increases. As this becomes clearer in economic data, we expect volatility to decrease and investor confidence to improve. We also know that unemployment currently remains low and jobs are plentiful (another key difference between now and the 1970s). Corporate earnings – the fundamental driver of stock market returns – continue to increase despite the inflation challenges.
Speaking of investor confidence, the current level of bearishness is very high. And historically, extreme negative sentiment has often been followed by strong market performance. To take just one example, the American Association of Individual Investors (AAII) has been doing a weekly survey since 1987. Last week’s survey had a level of bearishness seen only four other times before. S&P 500 returns a year later in those cases averaged over 30%. While we don’t know if that will repeat this time, it does bring to mind Warren Buffet’s famous adage to be fearful when others are greedy, and greedy when others are fearful.
It's also worth remembering that capital markets are forward looking. This is always true, but particularly instructive when prices are going down. If you and I both think a recession could happen, then that is already reflected in current prices even though that expected recession hasn’t happened yet. The reverse is also true: markets often begin to recover well before the economy turns the corner. This is exactly what happened in 2009 and 2020: when the economy was at its lowest, the stock market was already recovering.
There is no sugarcoating that the recent declines are concerning. We can’t be certain when exactly the volatility will end (and anyone claiming to know is likely more interested in selling a product than in providing tailored and sound advice). Bad markets like this are uncomfortable and difficult to navigate, but they are the psychological price we pay for the financial rewards of investing in capital markets over the long term. We do know that conditions continue to indicate that better times are ahead, and as long-term investors, that is our overriding takeaway right now.
We realize that in choosing to work with us, you place a lot of trust in our ability to help you navigate the good times as well as the bad. It’s a calling and a responsibility that we take very seriously. Please don’t hesitate to call or email any member of the team, so we can all navigate these challenging times together
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