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Market Commentary

Q4 2022 Outlook The 3 Ps…. Politics, Profits, and Peak (Inflation?)

Q3 Recap:

The third quarter was another difficult one for investors as global equities declined by -6.8% and core fixed income (Bloomberg Aggregate Bond Index) fell by -4.8%. This was the third consecutive quarterly decline for each of these indices, but they weren’t alone in their misery. Traditional safe havens like gold and U.S. Treasuries and perceived inflation hedges like commodities (which held up well earlier in the year) all traded lower in the quarter.
We believe the primary culprit for this broad sell-off is the Federal Reserve’s aggressive rate hiking campaign and its equally aggressive rhetoric. The resoluteness of the Fed’s hawkish posture led many market participants to increase their probabilities of a policy mistake by the central bank that would disrupt global financial markets.

Politics: Mid Term Election

Our political discourse remains challenged, however markets have historically rallied post midterm elections and, as it sits currently, a divided Congress remains the most likely outcome post November.  We have discussed this in previous commentaries; however, a divided congress typically means gridlock in DC, which Wall Street likes.  Gridlock means policy certainty and creates a sense of comfort for Wall Street. 

Additionally, year 3 of a presidential cycle has produced the best returns on average over the past 70 years.      

Our History
Our Process

Profits: Over time, the market is driven by profits and earnings.

Investors who have been following earnings predications or are perhaps reading about them now may be thinking: inflation can’t be good for markets going forward. There is a growing sense that falling earnings and earnings estimates must mean falling stocks, which for some investors also means considering changes to portfolio positioning.

But that’s not really how markets work. For one, U.S. stocks are already in a bear market, so weaker economic and earnings growth ahead has likely already been priced into stocks, at least to a degree. Consider what happened with earnings estimates in the early days of the pandemic. In the beginning of Q2 2020 – which was the last time earnings estimates fell by as much as they are falling now, analysts were slashing earnings forecasts to factor in the impact of the pandemic. But by the time earnings estimates started coming down, the bear market was already over.

Analysts are now starting to factor in the impact of higher interest rates on spending and earnings, but we would argue that the impact on markets has already been felt to a large degree. We would also expect the market to rally when expectations and sentiment about earnings and the economy are low and/or falling. There’s an old saying that “bull markets are born on pessimism.”

We saw earnings gloom in Q1 and Q2 this year, but in both quarters, we saw earnings per share growth and companies “beat” top and bottom-line estimates.  JP Morgan reported earnings on Oct 14th which really signifies the kickoff to the Q3 earnings season. JP Morgan beat top and bottom-line expectations. We will see if this trend continues for all other companies.  We believe it will as companies on average have passed higher labor and input costs to customers.  Additionally, companies have strong balance sheets, with over 7 trillion in cash, significantly more than historical averages.  

Inflation:

Inflation remains at historically high levels, however we are beginning to see signs that we are at or near the peak.  Commodity prices have come down, increased supply is meeting historically high demand, and supply chains are improving. As we’ve seen, the Federal Reserve is doing everything in their power to tamp down inflation by raising interest rates.  The Fed will either (1) win the battle in combating inflation where a soft landing becomes probable and the economy resists a sharp decline or (2) high inflation remains persistent, and the Fed is forced to hike interest rates even more aggressively. This will cause the economy to contract sharply, and corporate profits will struggle.     

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. The Press tends to amplify bearish voices in times of uncertainty- Drama means more viewers watching for longer periods. As we look towards the end of the year, we think there are reasons to be more optimistic about the potential for forward returns.

  • Despite the likelihood that the Fed will increase the Fed funds rate by an additional 1.25% by year-end, we believe the Fed is nearing a point at which it will be able to ease the pace of its monetary tightening.
  • The US consumer and US companies are in great shape financially ($7 trillion in corporate cash, $2 trillion in excess household savings).
  • Peak pessimism- Late June investor sentiment registered historically high bearish figures. The market tends to rebound when sentiment is very bearish.
  • Positive historical performance from a seasonal and midterm election perspective

If you have questions or concerns, we’re always available to talk.  Thank you for your continued trust and partnership.