Review: Third Quarter 2022

A Quick Note

Normally I begin my newsletter with comments on the condition of the economy and the markets. I’ve decided that for this newsletter, I will begin with the Numbers Review. This will be followed by my commentary.

Numbers Review

The S&P 500 index ended the quarter at 3586 compared with 3785 at the end of the last quarter, down 4.2%, and down 24.8% for the year. The S&P Mid Cap index ended the quarter at 2204, down from 2269 at the end of the last quarter, or 2.3%, and negative 22.5% year to date. The S&P Small Cap index ended at 1065 compared with 1128 at the end of the first quarter, down 4.5%, and 24% year to date. The MSCI ex USA index for foreign stocks declined to 247 from 324, for a loss of 28.3% year to date. The 10-year Treasury was 3.80% down from 3.09% at the end of the last quarter. The Bloomberg Barclays US Aggregate Bond Index yield went from 1.75%, at year end, to 4.73%, for a decline in the value of bonds of 14.61% year to date.

A look at what’s happening

I’ve been telling some of my clients that what we are seeing in 2022 is a give back of 2021. Let’s take a look at what I’m seeing. For the year 2021 the S&P 500 was up 26.9% while it is down 24.8% year to date. Last year the S&P Mid Cap index was up 23.2%, while this year it is down 22.5%. The S&P Small Cap index ended 2021 up 25.3% and is down 24% year to date. This does not make the pain of losses any easier to bear, but it puts what has been happening in perspective. The years 2019, 2020 and 2021 were exceptionally good years with the S&P up double digits in those three years. 2022 is a reversal of fortune.

On the other hand, fixed income has been a disaster. Interest rates had been at all-time lows coming into 2022. The Bloomberg Barclays US aggregate Bond Index was down 1.5% in 2021. So far this year the same index is down 14.61%. Bonds are normally a safe haven for investors. With inflation at a level not seen in years, and a Fed most interested on squashing inflation with massive rate increases, real rates on bonds have gone up and the value of bonds have come down.

A View of Where We Are

What has been helpful in the current environment is the use of shorter duration bonds, cash invested in short term government securities, use of value stocks and an emphasis on dividend and interest earning to help offset losses.

The Fed has indicated that they want to impact the economy by having wages stagnate and unemployment rise. These are painful and will impact the most vulnerable of our population. An increase in Fed Fund rates takes at least between 60 and 90 days to go thru the economy.

We are beginning to see the impact of the Fed Funds increases as mortgage interest rates have almost doubled, cooling the housing market, wages appear to have stabilized and major tech companies have announced large layoffs. Companies are preparing for a recession and are attempting to safeguard their earnings.

Where Might We be Headed?

The Labor Department released the consumer price index (CPI) report for September and the news on inflation was not good. The overall CPI increased 8.2%, over the same period a year ago. If there is good news, the CPI is down from 9.1% in June. Prices for housing, medical care and food have continued to rise. Housing costs, which makes up the largest share of the core index, rose the most since the 1980’s. Core inflation was up 6.6% in September, the biggest increase since August 1982. Fortunately, the producer-price index for core goods was the same as in August. This is the first month with no increase since May. This may indicate that inflation pressure is subsiding. It is likely that the Fed, after seeing these reports, will continue to raise the Fed Funds rate, pushing the current range of 3% to 3.25% up to between 4% and 4.5% by year end.

Conclusion

From mid-September through mid-November, major companies report their earnings. We will then see which companies have been able to pass along cost increases and maintain earnings. If earnings are stable this would be good for stocks, since earnings are important to value. With the Fed continuing to raise rates, the use of short-term bonds and cash are best for fixed investments. Historically, we would expect a late year rally of stocks that would push stock values up. One can only hope. On a positive note, the Social Security Administration announced that Social Security benefits would increase 8.7% in 2023! That was calculated based on the September CPI and is the largest in four decades.

Ed Mallon