Q4 Market Letter

By Jonathan Harper on October 11, 2022

Investors over the past decade grew accustomed to an economy that provided stable growth and a bull market that generally went straight up. Then the pandemic hit. Think back to 2020 – the global economy came to a standstill and we experienced a full-blown supply chain breakdown. Congress and the Federal Reserve continued to boost the U.S. economy through stimulus checks and a rapid bond buying program, respectively, all while maintaining record-low interest rates. These actions only further heightened market euphoria and unleashed high inflation. Fast forward to the end of last year, and only then did the Federal Reserve realize they were wrong, with Chairman Powell announcing in November an accelerated taper to asset purchases.[1] This admission that inflation was no longer “transitory” and that money supply was out of control meant interest rates had to start going up, and a new cycle was ushered in. 

Fast forward again to this past August’s Jackson Hole Symposium, which set the stage for current market sentiment. Chairman Powell cautioned that the Fed’s tightening cycle was, and may still be, far from over and that we’d likely experience “some pain” ahead for the economy[2]. Thoughts of the Fed reversing course on raising interest rates, the only economic lever they can pull to cool demand and growth, was and still is wishful thinking. The theme now is “higher for longer”, with the terminal rate for 2023 expected to move to around 4.6%[3]; this projection signals that rates will likely move into restrictive territory.

There are myriad economic factors to analyze: interest rates climbing means companies will likely see compressed margins and thus, lower earnings; a strong dollar, while helping fight domestic inflation, will reduce exports as goods become more expensive abroad; deflated consumer sentiment will bring curtailed spending, further reducing profit estimates; an energy crisis, spurred by the war in Ukraine, will continue to hurt the consumer; wage growth is out of control, with a labor market that is stubbornly too tight; a serious lack of supply versus demand in the housing market… want us to keep going? Bottom line – these conditions embody a likely recession, which is why we’d like to reset expectations. While nothing has “broken” yet, we continue to keep our eyes trained. Central banks will continue to adjust rates to fight persistent inflation. The market will continue to digest the data, providing investors with bouts of volatility in either direction, but we caution over-exuberance on bear market rallies. The chart below illustrates that all year-to-date downside pressure has been caused by price compression, but decreased earnings (the grey line) have yet to bake into estimates, which could lead to further downside on market prices. Third quarter earnings results, which started to print last week, will help paint a much more clear picture on how certain industries or specific companies are stomaching this volatility, which can change overall market outlook. Companies that have strong pricing power and healthy balance sheets should continue to be more resilient than companies that depend on lower borrowing rates of years past for future growth.

There is no question investors have been challenged this year. However, there are always opportunities for long-term investors. Short-term bonds are starting to become attractive for the first time in over a decade, with yields on 1-year U.S. Treasuries at approximately 4%[4]. Corporate profits are still strong, especially in companies that provide healthy free cash flow. We have worked hard this year to reposition for the next cycle, playing defense where appropriate. Regardless, be prepared for more modest returns, most of which will be generated through earnings and dividends. As always, we’d like to remind you of the long-term potential in markets; this short-term downside volatility is exactly what allows for strong performance over the long term. The chart below shows the impact of missing out on the top performing days in the stock market over the past 27+ years. For example, if you were not invested during the five best performing days over this time period, your annualized returns reduced from 7.7% down to 5.9%, or a difference of 1.8% per year. On a $100,000 initial investment, that’s a difference of almost $300,000 over that same time period!

There’s light at the end of this tunnel, we just don’t know how long the tunnel is. Making sure you stay invested in our thought process, that’s HMA!

[4]  https://www.federalreserve.gov/releases/h15

[1]https://www.federalreserve.gov/mediacenter/files/FOMCpresconf20211103.pdf

[2]https://www.federalreserve.gov/newsevents/speech/powell20220826a.htm

[3] https://www.wsj.com/articles/the-feds-march-upward-federal-reserve-raises-rates-jerome-powell-federal-open-market-committee-11663794626?mod=Searchresults_pos6&page=1