October 2022 - Market Update

Key Observations

The S&P 500 climbed from a business cycle low on October 12th to end the month up 8%. In fact, equity indexes across the board were remarkably resilient this month even in spite of some big earnings misses for market leaders in the tech sector. In tandem, interest rates have come down from peak rates as well. That price performance is likely being driven by the belief (or hope) that the Fed is coming closer to a pause, or at least a reduction in the level of rate tightening. We have seen some signs that the overheated labor market may finally be cooling and consumer demand waning (as evidenced by the latest tech earnings reports).

Note: We have now seen in the first week of November, the Fed said that it is “premature” to discuss a hike pause sending the markets down over 300 bps in reaction.

Data Dashboard

*Data Source: Bloomberg. As of 10/31/2022*

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Stock Market

Major stock indexes bounced back in October with the S&P up 8% and the NASDAQ up 4%. Overall earnings, outside of the tech sector, can be described as “not as bad as they could have been.” Earnings calls have placed the blame for weakness on macro factors and indicated forward looking guidance that is reduced but not reduced enough to reflect the likely realities of 2023.

The story of the last few days has been the large misses in the tech sector driven by a slowdown in advertising and higher inputs costs for electronics. The consumer is still spending, but inflation is starting to take a chunk out of discretionary spending, a tough way to enter the holiday shopping season.

Aside from the tech sector, Q3 earnings reports appeared to be (for the most part) resilient. Industries such as Industrials, Energy, and Consumer Discretionary saw double digit Earnings Growth in the third quarter mostly driven by sales growth, as opposed to margin expansion.

Stocks are trading in a range similar to level seen in June and July after an attempted rally in the third-quarter. It will be important to hold the $3,600 support for the rest of the year if the market is going to stage a Q1 rally and avoid another leg-down. Investors will be looking for easing prices for inputs and a minimal decline in consumer demand to keep companies growing for the rest of the year.

September Monthly Returns (by US Sector)

Bond Market

Interest Rates across the board were higher on the month, but the last week of October brought additional flattening of the yield curve. The 10-year US Treasury ended the month at 4.05%, up 0.22% from the end of September. The short-end of the yield curve (3-month T-bills) ended the month nearly the same rate as the 10- year. Since the end of the quarter, the 3-month rate has climbed higher than the 10-year, causing an “inversion”, meaning that the rate earned by owning a 10-year Treasury bond is LOWER than the rate an investor can earn lending money for 3 months. This is generally caused by the policy rate set by the Federal Reserve, and the view that short-term rates will come down in the future.

Investors are still feeling the pain of major decline in bond prices. This environment has been challenging for those that think of their bond portfolio as the safety net, only to find that their bonds are down almost as much as their stocks. While our clients have generally fared better given the active and strategic approaches we took to the fixed income markets post-COVID, the pain still exists. We expect bonds to remain under pressure for the rest of the year while the Fed completes its tightening campaign.

Economics

The economy is under pressure by design. The Federal Reserve is actively trying to slow down economic activity to ease inflationary pressures. So far, the economy is resisting the pressure to slow, but Fed official agree that tighter monetary policy has a lagging effect, and the changes being made now will take time to work through the economy. Fed Chairman Powell said that while he believes it is “still possible” for the Fed to achieve a soft landing, the path has “narrowed.”. Chairman Powell did not mince words when he indicated that the Fed will lean on the side of over-tightening and slowing the economy too much to get inflation under control.

Mortgage rates are still hovering in the 7% range, adding pressure to the housing market. Buyers may be incentivized to wait longer to buy a home and save up for a larger down-payment, removing the bidding wars and leaving houses on the market for longer. The housing market will cool as a result of higher borrowing costs, but the supply still needs to catch up to demand. Meanwhile, rental prices may be pushed higher as would-be buyers delay plans.

Bottom line… the economy needs to get worse before it gets better. But the stock market is already pricing in a slowing economy, so as long as “getting worse” isn’t too bad, the stock market should be primed for recovery on the other side.

Tactical Updates

For Tactical Equity portfolios, we successfully made our migration to individual stocks last week for clients with qualifying Tactical accounts. As you will now see, each relevant account should hold 50 individual stocks as we resume our typical Tactical trading strategies. Those that do not have qualifying account sizes will remain invested in and continually trade using the same Tactical universe as before (ETFs as opposed to individual stocks).

Since we are increasing the number of positions held in the Tactical portfolios, the number of trade confirmation emails will also increase. If you would like to consolidate them into a single summarizing email then please reach out to us and we can send you a consolidation DocuSign form that Schwab will use to make these changes on your behalf.

As for Tactical Fixed Income portfolios, we traded out of convertible bonds in favor of more floating rate treasury funds. This has had mixed effects because yields have continued to rise while equities have also rebounded for the month. The remainder of the portfolio stays invested at extremely short-term duration which has proven to be beneficial. Reminder: None of the changes that have occurred on the equity side of Tactical portfolios affect or will affect the fixed income or “low volatility” allocation of your accounts.

General Client Considerations

In 2023, the annual contribution limit for 401(k), 403(b), most 457 plans and Thrift Savings Plan is $22,500. This is an increase from the 2022 limit of $20,500. Additionally, if you are 50 or older, the catchup contribution limit for 401(k)s increased from $6,500 to $7,500. That means, in 2023, individuals who are 50+ in 2023 can contribute up to $30,000 to their 401(k)s.

The IRS changed the contribution limit for IRAs and ROTH IRAs from $6,000 to $6,500, and left the catch-up contribution at $1,000. The fall is the perfect time to plan for your retirement account elections so you can spread your contributions evenly throughout the year.

Many of you have already received RMD reminders for your IRA, but is another friendly reminder. If you are 72 or older and have not yet taken your RMD or are unsure if you have an RMD to take, please contact us to discuss. Additionally, if you have an inherited IRA and are unclear on the rules for taking distributions, please contact us.

Thanks,

The Friedenthal Financial Team

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