A Tale of Two Markets
3Q 2022
By Cliff Aque, CFA
The third quarter started out well, with stocks rising and interest rates slightly declining. Even in the face of interest rate hikes by the European Central Bank (ECB), the Federal Reserve (Fed), and the Bank of England (BoE), the markets continued a steady march higher towards recovery. But by the middle of August, markets did an about face, reversing all those gains and more.
Source: Brand AMG, Morningstar, Saint Louis Fed. Investors cannot invest directly in an index.
What happened? At the start of quarter, things were starting to look better with solid corporate earnings despite high inflation, showing that companies were weathering that storm. There were also some signs that inflation could be peaking as inflation had come down from June’s high. This, along with a comment from Fed Chair Powell who said at some point in the future it would be necessary to slow the pace of rate increases, led some investors to believe that the Fed might end its hiking cycle sooner than previously expected, and begin to “pivot” toward lower rates (the “Fed pivot” you may have heard about). By August 16, the S&P 500 was up almost 14% for the quarter.
Then in late August, the Kansas City Fed hosted its annual Jackson Hole Economic Symposium where dozens of central bankers, policymakers, academics, and economists gather to discuss economic issues and policy options. Comments from Fed Chair Powell and other central bankers made it clear that their priority was to continue fighting inflation rather than supporting growth. Powell warned that there would be “some pain” ahead and that the Fed would use its tools “forcefully.”
In mid-September, things got even stickier with the release of the August inflation report. The consumer-price index (CPI) rose 8.3%, which was below July’s 8.5% and June’s 9.1%, but the core CPI, which excludes food and energy, rose 0.6%, doubling July’s gain of 0.3%. Core CPI tends to be “sticky,” meaning that it tends to move more slowly in both directions. Seeing that inflation might be more persistent than hoped sent the markets tumbling, with the S&P 500 declining 4.3% on September 13th alone.
Finally, as if the markets needed more negative news, on September 21st Russian President Putin called up 300,000 reservists and said he won’t “bluff” on nukes, showing that he has no intentions of backing down in Ukraine. To end the month, the Bank of England had to intervene in its “Gilt” bond market after Parliament unveiled a huge tax cut package that sent the country’s currency and bonds tumbling. This set off a chain reaction in the country’s pension plans which were highly levered to gilts and they became forced sellers. Thankfully a crisis was averted, but it certainly added to volatility in the markets.
The combination of these events has led to a result we have not seen before, that being broad equity markets down over 20% and broad bond markets down over 14%. This has resulted in some of the most “bearish” (negative) sentiment ever recorded, which you may not know, is one of the strongest predictors of future growth. So let’s hope the future isn’t too far away.
It was quite a quarter with lots to talk about, but perspective is important, too. The markets never move in a straight line, and since the beginning of 2019, the S&P 500 is still up over 40%. It will take some time for the markets to adjust to higher inflation and higher interest rates. Until the Fed sees inflation head lower and finally pauses on its rate hikes, we expect volatility to remain elevated, but look forward to managing through this season and the better times that hopefully lay on the other side. As stated in our previous blog post, “as with past bear markets, you will endure this one…at least we’re not floating on an iceberg.”