2022 | 3rd Quarter
Before starting our usual market commentary, we would like to acknowledge that markets like we are experiencing this year are very unsettling. We all watch the daily news, open our statements, and wonder how things can change so quickly and dramatically. We’ll discuss our views on the markets and our current thinking below, but we would like to reiterate that we spend every day analyzing, reviewing, and revising our clients’ portfolios and plans, so that they can reach their financial goals. As we discussed in our last commentary, sometimes this means doing nothing, and sometimes more substantial changes are needed. We are dedicated to guiding clients through both good markets and bad. It is important to remember that the investments we select are for long term performance. Down markets happen frequently, and as seasoned investors we take that into consideration. Predicting when down markets will start, what factors cause them to start and end, and when the next upward trend in the market will begin are very difficult. History tells us that staying the course even when the wind blows hardest is the best way to investment success. Although the storm always feels that it will last forever, eventually the clouds part and the sun shines again. We know this because the companies we invest in are leaders in providing goods and services to the over seven billion people on the planet. As long as people continue to want products and services that make daily life livable and enjoyable, we believe that markets will rebound and that upcycles last longer than downcycles.
Stocks and bonds resumed their downward trend in the third quarter as the Federal Reserve continued to increase interest rates in response to ongoing inflationary pressures. Despite a brief rally in July and August, the S&P 500 was down 4.9% for the quarter. Hopes that the Fed would slow the pace of interest rate hikes faltered and fears of a recession that would crimp corporate earnings increased. For the year to date the S&P 500 had a negative 23.9% return, placing it firmly in bear market territory. Volatility based on daily events continued to be the norm. Events in Ukraine, ongoing disruptions due to Covid, particularly in China, and economic troubles in Europe related to energy shortages added to investors’ concerns over the inflation rate and central banks attempts reverse it without causing a painful recession.
In retrospect, policy makers now seem aware that the easy money polices that were put in place in response to the Covid-19 pandemic fueled inflation and lead to other distortions in both the financial markets and the overall global economy. The U.S. alone passed nearly $7 trillion in spending programs in addition to the Fed keeping interest rates at essentially zero and buying bonds through the end of 2021. Other nations around the world enacted similar stimulus programs. While the steps taken in 2020 were necessary to prevent an even worse economic downturn, it is now clear that continuing to infuse money into the economy through 2021, along with supply issues, fueled the inflationary environment we are now experiencing. Even though the latest inflation numbers have moderated slightly, they are still running at over 8% year-over-year. Since August, the Fed has made it clear they will do whatever is necessary to bring inflationary pressures down, which has led them to increase the Fed funds rate to 3.25% from 0.25% at the end of 2021. Predictions indicate the rate could reach 4.0% to 4.5% by the end of this year. U.S. stocks did better than international securities. While the S&P 500 was down 4.89%, international developed markets were down nearly 10% and emerging markets were down 11.5% as fears of slowdowns in Europe and China caused investors to reduce allocations to those areas. A strong U.S. dollar also negatively impacted foreign markets. Counterintuitively, small and medium sized companies, while still producing negative returns, outperformed large cap stocks. Smaller companies usually underperform during times of economic stress and rising rates. This may be due to large institutional investors selling their most liquid large cap holdings to shift asset allocations. For the first time this year growth stocks did better than value stocks, but value has still performed better for the full year by a large margin. Commodities, which have been strong all year, declined 10.3% but remained up 22% for the year.
With the dual fears of both higher interest rates and a possible recession looming very few sectors of the market posted positive returns. Market areas suffering the most have been segments that were the most speculative and highly valued such as emerging technology, meme stocks, and bitcoin. Energy remained the only sector with positive returns for the year and was up roughly 2% for the quarter as earnings were strong due to relatively high oil and gas prices. Certain areas of the consumer sector performed well which led to a 4.4% return. Financials and healthcare posted negative returns but less than the market. All other sectors were negative with the worst performing sectors being communications (-12.7%), real estate (-11%), and materials (-7.1%).
Turmoil in the bond market continued as rates on short-term fixed income instruments pushed towards 4%. All sectors of the bond market had negative returns for the quarter and the core aggregate bond index is down roughly 15% for the year. The yield curve became inverted (longer rates lower than short rates) as the market believed that inflationary pressures would ease in 2023 as the economy slows, and that the Fed would become more relaxed in its interest rate policy. We are beginning to see opportunities in the fixed income sector in the government and corporate bond segments as well as municipals. Current prices allow us in increase yield while decreasing volatility risk and we will be shifting weights accordingly.
Bear markets can be caused by numerous factors. Some are caused by structural factors, like the one caused by the 2008-2009 financial crisis. Others, like the market decline during the outset of Covid are event driven. We believe that we are in a cyclical bear market caused by the increase in interest rates and the fear of an impending recession. Investors are simply willing to pay less for future earnings on stocks now, even though earnings to date have held up reasonably well. We will be watching the data closely for the balance of the year. While employment remains strong, slowdowns in the housing market and shifts in demand in the services and goods markets due to inflation deserve attention. Cyclical bear markets typically last a year or so and produce returns close to what we have seen thus far, leading us to believe we are closer to a market bottom rather than another major move downward.
We appreciate the faith that you show in us to manage your investment portfolios and we remain solely focused on your financial well-being. As always, please contact us with any questions.
Jonathan F. Kolle, CFA
President
Joseph K. Champness
Managing Director
Shawn R. Keane, CFP®
Vice-President
Rusty Giles
Director of Marketing
James V. Kelly, CFA
Director
The foregoing content reflects the opinions of Smithbridge Asset Management and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct.
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