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Market Commentary

Q3 2022 Outlook

As we look ahead into the rest of the year, we wanted to provide our outlook and expectations going forward into Q3 and the rest of the year.  The first half of this year was volatile to say the least, which resulted in the second worst year-to-date start in stock market history (the worst being the Great Depression).  Below we address some of the topics that have dominated news headlines recently, but we still believe the fundamentals for equity investment are positive going forward and still the best way to combat inflation, protect, and grow your wealth.

Looking ahead

1. Inflation- Higher for longer

We expect inflation to moderate in the second half of the year, although we do believe it will stay elevated above the 40-year average of 3.8%. Supply chain disruptions, China’s zero-Covid policy, and the Russia-Ukraine War are all still serving as headwinds for the Federal Reserve to combat inflation. Between pent up demand coming out of Covid and government stimulus, demand for goods skyrocketed in 2021 creating a supply shortage in goods. This year however, consumer spending has begun to shift from goods to services and as the demand for goods lessens, the supply-demand imbalance will come back to equilibrium in 2023. We believe the headwinds for inflation are short-term however, and overall long-term inflation is driven by permanent disinflationary forces such as technology and innovation, ongoing globalization for production, and central banks normalizing interest rates.  

2. US Fundamentals are still in good shape

Overall US fundamentals are positive which should provide some cushion against rising inflation and higher interest rates.  Household balance sheets are very strong.  Asset values and cash balances are up, while liabilities are down compared to pre-pandemic levels.   Consumers are poised to spend more money.  Additionally, unemployment numbers are near pre-pandemic lows and demand for workers is outpacing those looking for a job, again a sign of strength.

3. Is all the bad news already priced in?

There is a silver lining.  Because stocks suffered their worst first-half performance since 1970, and most bonds posted notable negative returns this year too, a lot of bad news may already be reflected in asset prices. Positive surprises from the Fed, inflation data, the Russia-Ukraine War, or China could result in a second half rebound in risk assets.

One of the lasting investment lessons from the pandemic is that the economy is not the market. The market is a forward-looking mechanism. Investors were reminded of this when risk assets rallied aggressively during the height of the pandemic’s challenges. Investors were already pricing in a strong recovery.

In the meantime, the key barometer for market sentiment will be the closing of the gap between inflation figures and the Fed’s terminal rate. The terminal rate being the rate set by the Fed that is neither accommodative nor restrictive (it’s the interest rate that isn’t boosting growth or slowing it down). If that starts to happen, markets may begin to rally. If the gap remains stubbornly high or worse, it widens, we can expect continued volatility with risks skewed to the downside. Although counterintuitive, we may be in an environment over the next 6 months where somewhat bad economic news is good news for the markets because that will indicate the Fed’s actions are having some impact on demand and should abate inflationary pressures.

As always, it’s imperative to maintain a long-term investment perspective during times of volatility. This year’s correction has removed a significant amount of excess that had been built up in the market, and equities are approaching more fairly priced levels.  We cannot be certain if the market has troughed yet, however we did reach bear market levels a few weeks ago.  Past performance is no guarantee for the future, however the market historically rallies in the months following a bear market. 

You can be confident that we’ll continue to monitor economic conditions and let you know if there’s anything we need to change or address. Most importantly, don’t let today’s headlines distract you from tomorrow’s goals. If you have questions or concerns, we’re always available to talk.