Third Quarter 2022 Review and Outlook
Written by Tim Rigby
The third quarter experienced more volatility as the Federal Reserve continued to raise interest rates in a bid to squash surging inflation. According to The Wall Street Journal, the returns were as follows:
Quarter YearThe Dow Jones Average -6.66% -20.95%
The S&P 500 -5.28% -24.80%
The NASDAQ Composite -4.10% -32.40%
The Federal Reserve Bank has been aggressively raising rates this year to attempt to slow the economy and help calm inflation that almost seemed out of control. Monetary policy works with a lag, so the rate increases from earlier in the year are just now starting to slow the economy and inflationary pressures. The economy is struggling under the weight of higher interest rates. Mortgages for a home are now around 7% which is up from 3% earlier this year. That is a huge increase in a very short period of time.
Rising interest rates are a rare phenomenom in the bond market as rate cycles tend to be decades long. Our suggestion the last few years was to avoid bonds because when interest rates rise, the value of most bond holdings decline. We really haven’t seen a prolonged rise in rates since the 1980’s! With rates near zero during the Pandemic, our fear was bond prices would decline sharply if interest rates rose. That has now happened and rates have risen even more quickly and more sharply than we expected. The silver lining is there are now options to earn interest on cash for the first time in a decade. However, until the Federal Reserve completes hiking rates, our view is to wait a little longer to invest as we believe we can lock in even higher bond or CD rates in the next month or two.
The stock market has had a very difficult year as you can see in the returns shown above. If government statistics are released that hint of any slowdown in the economy or inflation, the market rallies strongly. If the statistics show strength in the economy or inflation, the stock market immediately drops sharply. This may continue for another month or two as the fear is the Federal Reserve will overdo the interest rate increases and push the economy into a serious recession. Since policy works with a lag, many economists
are saying the Fed should pause the rate hikes and give things time to settle down. Prices of many commodities are down from their highest prices, so hopefully inflation will start to moderate soon.
Overall, it is our view that the stock market has gone from overvalued in certain areas to undervalued in many sectors. Prices are now way below the long term trend line which shows stock prices increase by the rate of inflation plus 2% or so per year. Quite a few companies have also increased dividends, have strong balance sheets and yet their stock prices have dropped sharply. It is possible there will be a very strong rally whenever the Federal Reserve hints that they have finished with rate increases. That is probably a few months away so we continue to recommend building up cash in portfolios for now. Ultimately, there will be some great buys before the next up cycle starts.
Last but not least, the war in Ukraine continues to rage on with no end in sight yet. Should that conflict be resolved somehow, that would remove a huge risk and probably prompt a strong rally as well. In the meantime, it is a worry that will keep all markets on edge.
Enjoy some beautiful fall weather and give us a call if you have any questions or concerns.
Tim Rigby