Authored by :
Michael G. Dow, CAIA, CFA, CPA, Chief Investment Officer
Julien R. Frazzo, Director of Risk Management and Securities Research
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The Quick Facts
- The S&P 500 and Nasdaq wrapped up their first three-quarter losing streak since 2009, losing 4.9% and 3.9%, respectively in 3Q 2022
- Two more FOMC meetings by year-end with 125bps of Fed hikes expected
- Yields on the benchmark 10-year Treasury note hit their highest level since 2008
- Inflation remains hot. Core CPI (ex. food & energy) surges +0.6% m/m and 6.3% y/y in August
- All eyes on the next CPI print on October 13
U.S. stocks suffered their worst monthly rout since March 2020 after markets were repeatedly pummeled by the Federal Reserve’s (Fed) resolve to keep raising interest rates until inflation is under control. The S&P 500 closed a volatile month 9.2% lower (-23.9% YTD). The index posted its third straight quarter of losses for the first time since 2009. Despite making a comeback in July and the first half of August, the S&P 500 slumped to a loss of 4.9% for the quarter.
Risk assets have been in a tailspin since the central bank delivered a third 75bps hike in late September and repeatedly warned of more rate hikes to come. All eyes will be on the next CPI (Consumer Price Index) print on October 13 and the earnings season, which starts mid-October, for insight into how companies are managing through headwinds that include a strong dollar, rising costs, and slowing demand. Fears of a global recession are mounting as the threat of higher rates saps growth and operating margins.
The FOMC (Federal Open Market Committee) summary of economic projections now calls for a median Fed Funds rate of 4.4% at the end of 2022 and 4.6% at the end of 2023. There is a willingness to tolerate below-trend growth and even a recession if necessary. Long-run inflation expectations are still anchored, and the Fed wants to keep it that way. Fed Chair Powell noted in his press conference that he remained committed to price stability and reiterated that the Fed would “keep at it” until the job is done. There was little change in the message since Jackson Hole.
On a total return basis, Energy and Consumer Discretionary were the only two positive sectors in 3Q 2022, with a 1.8% and 3.8% return, respectively. Year-to-date, the Energy sector remains the only sector in the green with a 33.8% total return, followed by Utilities with -6.5%. The other nine sectors are all down double-digit percentages year to date, with Technology and Communication Services down the most, 31.2% and 37.9%, respectively.
The Russell 1000 Value was down 8.8% in September, outperforming the Russell 1000 Growth by 0.9% in September and 12.9% YTD. The outperformance of Value over Growth continues to be a major investment theme in an environment where long-dated cashflows get discounted at higher rates. The ESG segment of the market, as measured by the MSCI USA ESG Select Index, was down 9.9% in September, 0.8% more than the S&P 500. Over the last three years, the ESG index is up 28.8% and approximately 2.3% ahead of the S&P 500 on a total return basis. Outside of the U.S., international equities did even worse. The MSCI Emerging Markets Index posted an 11.7% loss in September and is now down 27.2% YTD. The MSCI EAFE (Europe, Australasia and the Far East) Index was down 9.3% in September, underperforming the U.S. Large Cap equity benchmark by 0.1%. After a period of underperformance earlier this year, U.S. equities, as measured by the S&P 500, are now outperforming both MSCI Emerging Markets and EAFE as of the end of 3Q 2022.
The yield on the benchmark U.S. 10-year Treasury now stands at 3.83%, a level last reached in 2010. The yield on the shorter-term 2-year Treasury recently touched 4.34% following the Fed’s September meeting, which is the highest it has been since 2007. The yield curve inversion got worse in September, with 2-year Treasuries yielding 45bps more than 10-year maturities as of September 30. Treasury rates have seen a historic rise driven by inflation and the hawkish Fed. Just in the last two months, the 2yr, 3yr, and 5yr yields have risen 140bps.
The U.S. CPI rose +0.1% m/m in August, and 8.3% y/y. The core CPI (ex. food & energy) surged +0.6% m/m and 6.3% y/y. The overall CPI print which was lower than the 9.1% or 8.5% seen in June and July, respectively, was nevertheless higher than expected, given the retreat in oil prices. A significant contributor to inflation was rapidly rising rents, which rose 6.7% from a year ago — the fastest growth in nearly 40 years. Rent prices look to accelerate in the near term as rental demand remains exceptionally high from ongoing job additions and higher mortgage rates forcing people out of the home-buying market. The one-month gain in rent was 0.8%, which translates into a hefty 9.6% annualized gain. Increasing the housing supply and/or a cooling off on the demand side will be necessary to lessen the pressure on rent inflation.
Oil prices declined 11.2% in September. WTI Crude traded as high as $123.70/bbl back in March, a 14-year high. YTD oil is up 5.7%, but it is off 35.7% since that March high. Gold declined by 2.9% in September and is down 19.1% from the March highs of $2,050. For 2022, gold is down 9.2% and is not working as an inflation hedge. The U.S. Dollar Index was up 3.1% for the month, 7.1% for the quarter and 17.2% YTD. The U.S. dollar continued to strengthen, trading at an all-time high against the British pound (1.0350), as the Euro, which last month broke under parity to the U.S. dollar, reached a low of 0.9538. Cryptocurrencies were also hit by the general sell-off. Bitcoin was down 3.8% in September. Mid-September 2022, Ethereum officially switched over to a proof-of-stake model, in a well-anticipated event called “the merge.” Nevertheless, Ethereum was down 15.2% during the month. Bitcoin and Ethereum are now down 58.1% and 63.9% YTD, respectively.
Volatility picked up at month’s end following a hawkish FOMC meeting on September 21. The CBOE Volatility Index (or VIX), a popular measure of the stock market’s expectation of volatility based on S&P 500 index options, also known as the fear gauge, was trading in the mid-20s until the Fed’s hawkish comments sent the index to the 30s for the fifth time this year. The VIX closed out September near the month high at 31.6. While equity investors look to the VIX index as a measure of volatility, bond investors focus on the ICE BofA MOVE (MOVE) Index, which measures bond market volatility. The MOVE Index has more than doubled this year and hit the highest level since the pandemic crash. By contrast, the VIX has yet to take out its June peak.
Chart of the Month – Labor Market “Tug of War”
The U.S. labor market is still looking tight by numerous metrics. U.S. nonfarm payrolls rose a solid 315,000 m/m in August, pointing to broad-based hiring across many sectors, but well down from the prior month’s 526,000. The unemployment rate rose to 3.7%, with labor force participation up to 62.4%. The unemployment rate remains close to its pre-pandemic level, and job openings remain elevated.
The U.S. labor force participation rate held steady at around 63% until the COVID-19 pandemic struck. It was 62.4% as of August 2022. The rate varies over time based on social, demographic, and economic trends. Global labor force participation has shown a steady decline since 1990.
An additional sign of stress in the labor market is associated with job openings, the most common tracker coming from the Job Openings and Labor Turnover Survey (JOLTS). A key measure of labor market tightness has been the relationship between job openings and the number of unemployed people, with the former outnumbering the latter by a ratio of 2 to one.
The Non-Accelerating Inflation Rate of Unemployment (or NAIRU, the green dotted line in the Unemployment Rate graph to the right) is the lowest unemployment rate that can be sustained without causing wages growth and inflation to rise. It is a concept that helps gauge how much slack there is in the economy. We should expect wage pressures to continue as long as the unemployment rate is below NAIRU.
Quote of the Month
“Earnings don’t move the overall market; it’s the Federal Reserve Board … focus on the central banks, and focus on the movement of liquidity … most people in the market are looking for earnings and conventional measures. It’s liquidity that moves markets”
– Stanley Druckenmiller
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