Market Update September 27, 2022

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The U.S. Federal Reserve raised rates again to the degree expected, in efforts to combat inflation. Economic results for the week included mixed housing data, with sharply higher starts coupled with weaker homebuilder sentiment. The index of leading economic indicators continued to fall, reaching an important recession warning signal.

Global equity markets fell back on the week, as rising central bank policy rates fueled fears the economy will ‘break’ and tip into recession. Bonds declined as well, with yields ticking up across the maturity curve to multi-year highs. Commodities fell back broadly upon the same recession fears and more direct concerns of lower demand.

 U.S. stocks were mixed early in the week, with investors anticipating the Wed. FOMC meeting. However, a disappointing report from Ford caused the market to negatively react to potentially more difficult conditions to come, similar to FedEx the prior week. The Fed meeting itself, the hawkish dot plot, and press conference caused several back-and-forth swings in market sentiment before declining further late in the week, as markets assumed ongoing rate hikes would indeed ‘break’ the economy, pushing it into recession. Several well-watched Wall Street strategists downgraded market expectations for the rest of the year, which further soured market sentiment. Every sector lost ground, led by energy and consumer discretionary, which were down 7-9%. The usual defensive sectors, utilities, staples, and healthcare, on the other hand, fell lesser 2-3%. Real estate was down -6% with the headwind of higher interest rates, which continue to challenge financing costs.

Relative to the Jan. 3 peak, the S&P 500 initially troughed at -23% on June 16, before rebounding sharply through mid-August. Now, it’s fallen back to nearly the same place, which could prove to be an important technical level. It’s worth a reminder that historical pre-recession bear markets, at least in the modern era, experienced a median peak-to-trough decline of around -25% to -30%. (By median, this implies some bears were less severe and a few more severe, always causing concerns that the current bear is an especially ‘bad’ one. However, those worse than -30% tend to be more of the structural variety, or associated with sharply overheated asset or credit levels.

Foreign stocks underperformed U.S. equities, with a sharply stronger dollar (+3%) acting as a headwind. Europe and the U.K., most heavily affected by Russian rhetoric and winter natural gas concerns, lagged Japan and the emerging markets. The Bank of England raised rates by 0.50%, as did the Swiss by 0.75%—the latter being its largest hike ever, and ending nearly a decade of negative interest rates. Following a stretch of very strong weakness in the yen, Japanese officials have publicly discussed foreign exchange interventions to boost its value for the first time in decades. This weakness have been the result of a stronger U.S. dollar, as well as compared to other currencies, as Japan remains the sole major central bank that hasn’t begun a rate-hiking regime. Higher rates tend to result in stronger currencies, and given the limited levers a government has available, one lever usually has to give, and it’s often the currency value, as that has a more subtle effect on domestic consumers. Interestingly, the Brazilian central bank elected to keep policy rates unchanged (at 13.75%), and noted the rate-hiking regime is over—which caused the Brazilian stock market to rally, in contrast to all others.

U.S. bonds fell back in keeping with rising interest rates across the curve, although the impact on the longer end was possibly less dramatic than some expected considering the Fed’s hawkish language. Corporates underperformed treasuries a bit, due to the impact of widening credit spreads. Foreign bonds fell back, especially in developed markets, due to the impact of the stronger dollar.

Technically, after a few false starts, the 10-year treasury yield rose above 3.5% for the first time in over a decade, in advance of the Fed hike, and fueled by Sweden’s rate hike by a full 1%. However, the Fed’s actual decision didn’t move the needle as much after that. When looked at in context of 10y-2y yields, the treasury curve inversion has continued to widen (by -0.50%), which has correlated to rising expectations of recession. The more near-term relevant 10y-3m signal has not yet inverted, but the Fed move last week makes this a foregone conclusion in coming weeks.

Commodities fell back generally, led by declines in energy and metals, due to increasing recession fears in keeping with higher interest rates and a strong U.S. dollar (which tends to have an inverse relationship with commodity prices). Crude oil fell by over -7% to just under $79/barrel, with natural gas down -10%. Oil prices also appeared to be pulled down by an extension of releases from the U.S. Strategic Petroleum Reserve. After a steep drop earlier in the year, following little change at all in 2021, the copper/gold ratio has begun to improve, in a piece of positive news. Historically, this has been seen as a bit of an early indicator of improved economic optimism (and improved equity market returns when in the lowest range, as is the case currently).

Period ending 9/23/20221 Week (%)YTD (%)DJIA-4.00-17.30S&P 500-4.63-21.61NASDAQ-5.06-30.13Russell 2000-6.58-24.48MSCI-EAFE-5.60-26.10MSCI-EM-4.03-24.70Bloomberg U.S. Aggregate-1.56-13.75

U.S. Treasury Yields3 Mo.2 Yr.5 Yr.10 Yr.30 Yr.12/31/20210.060.731.261.521.909/16/20223.203.853.623.453.529/23/20223.244.203.963.693.61

Sources:  LSA Portfolio Analytics, American Association for Individual Investors (AAII), Associated Press, Barclays Capital, Bloomberg, Deutsche Bank, FactSet, Financial Times, Goldman Sachs, JPMorgan Asset Management, Kiplinger’s, Marketfield Asset Management, Minyanville, Morgan Stanley, MSCI, Morningstar, Northern Trust, Oppenheimer Funds, Payden & Rygel, PIMCO, Rafferty Capital Markets, LLC, Schroder’s, Standard & Poor’s, The Conference Board, Thomson Reuters, U.S. Bureau of Economic Analysis, U.S. Federal Reserve, Wells Capital Management, Yahoo!, Zacks Investment Research.  Index performance is shown as total return, which includes dividends, with the exception of MSCI-EM, which is quoted as price return/excluding dividends.  Performance for the MSCI-EAFE and MSCI-EM indexes is quoted in U.S. Dollar investor terms.

The information above has been obtained from sources considered reliable, but no representation is made as to its completeness, accuracy or timeliness.  All information and opinions expressed are subject to change without notice.  Information provided in this report is not intended to be, and should not be construed as, investment, legal or tax advice; and does not constitute an offer, or a solicitation of any offer, to buy or sell any security, investment or other product.