September 2022 - Market Update
Key Observations
- Stocks across the world retreated back to the lows in September, driven by renewed fears of a global recession. While this is an update based on September, it is worth noting that Markets rallied for a positive first week of October.
- Continued rhetoric and policy moves around rising interest rates, concerns over oil disruptions, and geopolitical factors kept pressure on world equity markets and forced investors to reevaluate near-term risks.
- Higher volatility was seen in both bond and currency markets as well.
- Investors will be focused on full-year outlooks during 3rd quarter earnings calls.
- The unemployment rate will need to increase before the Fed will take its foot off of the pedal.
Data Dashboard
Stock Market
The S&P 500 fell more than 9% in September to fresh lows before rising nearly 4% in the first few days of October. After Federal Reserve Chairman Jerome Powell spoke firmly about the commitment to controlling inflation and the likelihood of economic pain as a result, markets priced in short-term contraction in economic activity and stock prices fell.
Given that stocks are still down more than 20% for the year, it is clear that markets are expecting a short-term reduction in corporate earnings and consumer demand. But it is worth noting that earnings estimates are constantly fluctuating, and analysts are still expecting positive earnings growth for 2022 and 2023.
On a sector basis, much of the earnings growth in the S&P 500 will come from the Energy and Industrial sectors. Energy sector earnings are expected to more than double compared to last year, while Financial and Communication Services earning are expected to decline year-over-year.
The near-term focus will be on company outlooks after they report their 3rd quarter results.
September Monthly Returns (by US Sector)
Bond Market
Bond yields spiked higher in September, with the 10-year US Treasury ending the month at 3.83%, compared to 3.19% at the end of August. Fixed Income investors continued to feel the pain of rising yields, on top of the effects of lower confidence in corporate borrowers. The yield on risky debt (Junk Bonds) eclipsed 10% in September, signaling the increased fear that lower-quality borrowers will not be able to meet their obligations and increase the rate of corporate default.
The TIPS market continued to price in a declining rate of inflation, an expected phenomenon given that the Fed is pot-committed to bringing down the inflation rate. Just 6 months ago, the 3-year expectation was more that 4% per-year of inflation, while that rate was just 2.05% at the end of September.
Economics
As expected, September’s Fed speaker schedule offered more of the same messaging around getting inflation under control by committing to staying the course on raising rates. Cleveland Fed President Mester even stated that policy rates are not yet at the “restrictive level.” Headline inflation is declining due to lower oil prices, and core inflation is expected to follow suit.
The labor market remains tight compared to long-term averages. The Fed considers “full employment” to be somewhere between 4.1-4.7%. The current unemployment rate in the US is 3.7%. Fed Officials have made it clear that there will need to be an increase in the unemployment rate to help ease wage pressure, a major component in inflation.
Market volatility has been felt worldwide. CPI numbers out of the Eurozone last week solidified expectations of a 75bp hike in October while the Bank of England stepped in to buy UK government bonds last Wednesday to attempt to restore orderly market conditions. Global central banks have historically been behind the US in action, but the global inflation issue has caused many developed countries to keep their economies healthy.
Tactical Updates
For Tactical Equity portfolios, we ended the month of September with only a couple of trades, dropping out of Healthcare and Home Builders for exposure to Brazilian and Indian equities. Japanese equities and Utility sector stocks are our longest holding period positions at almost 150 and 200 days respectively. In addition to those exposures, our current portfolio has positions in Solar, Lithium battery, and Biotech companies, as well as Oil MLPs. Our Tactical Equity portfolio continues to perform well relative to its benchmark the All Country World Index (ACWI).
As for Tactical Fixed Income portfolios, we ended the month of September in a much shorter duration portfolio than prior months including positions in floating rates and ultra-short bonds. We turned over our entire portfolio of high yields, mortgage-backed securities, and ex-US international bonds for short-term corporates, floating rates, and convertible bonds. Each of which have performed relatively well due to increase in yields.
General Client Considerations
When faced with market uncertainty like we’ve experienced this year, it’s common for investors to feel the urge to try and time the markets or make major changes to their portfolios. While it may initially feel good to exert some control in a volatile situation, as we’ve stated in the past, panicking when facing a bear market rarely leads to the outcome that you hope to achieve. Timing the markets involves being “right” twice – picking the top AND picking the bottom. Otherwise, all selling achieves is locking in a loss.
When we evaluated your financial needs, goals and risk tolerance we factored in historical periods of decline. The goal is to ensure you would be able to withstand this type of market decline. We hope that you can take some comfort in knowing that based on that analysis, we established a portfolio allocation that you should be able to maintain through periods of market volatility.
Thanks,
The Friedenthal Financial Team