Markets remained depressed as the third quarter of 2022 ended. An aggressive FOMC and a continued hawkish tone due to stubborn inflation continued to drive liquidity out of risk markets. The strong dollar, global market dislocations, and threatening remarks from Putin also created headwinds.
The Federal Reserve Bank unanimously raised rates 75 basis points on September 21st. It was the third consecutive 75 basis point hike, the fifth hike in 2022, and has lifted the federal funds rate to a 3.00%-3.25% band. Expectations have been increased to a 4.25% Federal Funds target by year-end.
While Fed officials have been consistent with their message, investors are looking for any signs of “dovish” comments. The Fed is continuing to move expeditiously, and monetary policy tightening will persist until inflation eases. Market participants are beginning to see signs of slowing, and cracks in economic activity. Companies are also sounding alarms as earnings and profitability are in jeopardy.
The S&P fell by -9.22% in September, as interest rate-sensitive sectors including information technology and real estate fell over -12% each. This was the worst total return for a September in 20 years. Equities broadly sold off with healthcare faring the best, down -2.74%. Equities begin the fourth quarter firmly in a bear market territory as the S&P has fallen -23.88% this year and has broken through the June trough. Growth has led the retracement, as the Nasdaq has fallen -32% in nine months and was down over -10% in September alone.
Interest rates continued to soar last month, and the historic moves have affected all parts of financial markets. This year has eclipsed the “Volker-1994 bear market” in terms of the magnitude of rate movement.
- The 10-year treasury moved approximately 63 basis points from 3.19% to 3.78% and briefly touched 4% on September 28th. We have not seen 10-year yields at this level since April 2010.
- 2-year treasury yields continue to have even more dramatic moves, coordinating with expected FOMC policy moves. This sector rose 78 basis points to yield 4.28%, further inverting the yield curve and reaching levels not seen in 15 years.
Credit markets saw continued pressure as spreads widened in a recessionary-like trading environment. Falling stock markets, the potential for higher default rates, the rising cost of corporate capital, and a strong dollar are intimidating investors from supporting investment grade and high yield sectors. Market volatility has kept primary issuance at much lower levels. Despite lower total returns, investors are taking notice of the relative value in absolute yields offered by investment-grade bonds. Five-year corporate bond yields above 5%, offer some longer-term value to dividend investors, which could lead to a “disintermediation” from equity markets to bonds.
As Chairman Powell stated last month. “We have to get inflation behind us. I wish there were a painless way to do that. There isn’t”. This stern, but the clear message has given investors a good deal to think about as we begin the fourth quarter. Bond investors are trying to picture how high rates can extend before something “breaks” in the economy.
Economic data remained solid last month, which has turned into somewhat of a negative catalyst to risk markets, as restrictive monetary policy could be higher and longer.
- Non-farm payroll figures came in slightly above expectations, and average hourly earnings remain elevated.
- CPI, PPI, and core PCE came in at or above expectations giving no indication of any broad-based slowdown in inflation.
- Retail sales excluding autos slowed a bit during August, but surprisingly both existing homes sales and new home sales were stronger despite higher mortgage rates.
- Some signs of regional manufacturing have slowed, and surveys on consumer confidence are slightly lower.
We took notice of some company-specific announcements that could lead data as we begin the final quarter of 2022. The strong dollar and higher rates will be a footnote for global companies’ future earnings reports. This could be leading the economic data and the future of jobs and economic growth in the US.
- Fed-Ex withdrew its earnings forecast due to much worse business conditions.
- Meta announced jobs cuts.
- Apple announces lower demand for their new iPhone.
- Nike had sales fall globally and continue to see supply chain issues.
As the last week of September ended, global news rattled markets and reminded investors of potential “tail-risks” and “black swan” types of events.
- While the Bank of England has also been fighting inflation, their new Prime Minister, Elizabeth Truss, enacted a messy tax cut plan. The plan created pressure on their currency and a sharp selloff on their government debt. The Bank of England had to step in, and offer a temporary bond-buying program (yes, even as they are in a rate tightening posture). This reversed the free fall of their bonds and currency. The pound came close to parity with the US dollar, and many described the wild swings as more “emerging market-like,” rather than a developed economy.
- On the last day of the month, Russia claimed to annex four Ukrainian provinces and the war continued to on weigh financial markets. More frightening to everyone, have been speeches by Russia’s Putin, suggesting a nuclear option is not off the table. Cash and risk-free bonds see in-flows after news reports describe the Russian leader as “being backed into a corner.”
The bond market sell-off this year has been the sharpest since 1994. While circumstances have been different, the catalysts (aggressive FOMC tightening of monetary policy due to inflation) are similar. Parts of the yield curve have moved to 15-year high points, creating interesting valuations in the bond market. With investment grade corporate bonds reaching yield levels of 5% plus, equity valuation models for equities have changed, and we could witness a “disintermediation” from stocks to bonds, as interest income trumps stock dividends. A recession is the future base case for most economists, which is usually supportive of bond prices. In addition, the volatility as rates rise is beginning to cause instability in global currencies and markets. The Federal Open Market Committee has been extremely hawkish on short-term interest rates this year. Some parts of the economy and inflation are now showing signs of slowing. At some point, the Fed may need to shift to a “wait and see” approach to restricting monetary policy further. In 1995, one year after Volker’s famous inflation fight, the total return of the bond market index rose 19+%.
The Piton team continues to offer customized portfolios and solutions to meet your needs through all market and interest rate environments. Please let us know how we can help you and your clients, we are here to serve as an extension of your team.