After a dire second quarter, in which the S&P 500 Index entered bear market territory in June, the third quarter began with a much-needed breath of fresh air. Stocks enjoyed a strong rally thanks to good corporate earnings reports and a positive response to Federal Reserve policy. The index returned 9.22% for the month of July, marking its eighth highest monthly return since 1988. Additionally, the Bloomberg U.S. Aggregate Bond Index returned 2.44% in July. 

The encouraging trend continued into the first half of August. The S&P 500 gained 4.3% through August 16th, bringing the rally to double digits. I wish I could end my letter here. Unfortunately, the second half of the quarter did not fare as well as the first half.

Spooked by Fed Chair Jerome Powell’s speech at the Jackson Hole Economic Symposium where he commented that interest rates would need to remain higher for longer, the S&P 500 fell by 8.1% to close out August, making the total return for the month -4.1%. An increase in interest rates also put downward pressure on bond prices throughout the month. The 10-Year Treasury yield increased from 2.65% to 3.19% in August, causing the Bloomberg U.S. Aggregate Bond Index to decline by -2.8%. At the end of August, the index was down by 10.8% for the year, which is the worst start to a calendar year since the inception of the index in 1976.

The bad news continued into the month of September. The S&P 500 closed the books on its steepest September decline in two decades. Furthermore, the third quarter of 2022 marks three quarterly declines in a row, the longest losing streak for the S&P 500 and the Nasdaq since 2008 and the Dow Jones Industrial Average’s longest quarterly slump in seven years. Ugh.

I think at this point, you get my message that it has been a rough quarter, not to mention a rough year. What’s causing all of this havoc in both the equity and bond markets? Well, there are many factors, but the root of the problems rhymes with the infamous real estate saying, “location, location, location.”  The underlying culprit is inflation, inflation, inflation.

The question now is how fast can inflation fall, and where does it come to rest? Recession is a growing risk as the Fed remains focused on combating inflation through higher rates, which tend to hamper economic growth.

As expected by many, the Federal Reserve announced a third consecutive 75-basis-point rate hike at its recent meeting in September. What wasn’t expected was that the Fed’s target keeps rising for where it thinks rates will need to go. The new target is expected to be above 4.5%, which implies another 150 basis points of rate hikes later this year and early in 2023. Fed Chair Jerome Powell has been very clear that the Fed’s goal is to reduce inflation, regardless of whether it causes a recession.

Other notable activities of the third quarter include the soaring dollar against major foreign currencies and the passage of the Inflation Reduction Act.  The dollar is up about 7% for the quarter against other currencies and stands near its highest level since May 2002. Check out Nick’s article in our newsletter for details on the Inflation Reduction Act.

The ongoing transition in the economy and markets is likely to be bumpy. However, for long-term investors, we believe this difficult economic environment has created opportunities for investors willing to live with some short-term discomfort. We believe those who were able to either stay invested, rebalance, or add to their existing holdings will eventually be rewarded.

We encourage you to maintain a long-term viewpoint as the present environment is very volatile. Given all the uncertainty, we are maintaining a disciplined approach while continuing to look for opportunities to tax loss harvest, reposition and rebalance portfolios, and selectively put money to work for clients that have recently made contributions to their accounts.

Thank you so much for allowing us to serve you. We take our role in your financial journey very seriously and are honored to be a part it. As we head into the final months of the year and the holiday season, we wish many blessings for you, your family, and friends.

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