Third quarter market report

REALITY SETS IN

The third quarter of 2022 was a roller coaster for markets. After hitting yearly lows in mid-June, markets rallied in July and into the first half of August. The catalyst for the mid-quarter rally? A mostly flawed notion on the markets’ part that the Federal Reserve would pull back from its aggressive stance on raising interest rates in an effort to combat inflation.

However, comments from Fed Chair Jerome Powell on Aug. 26 made it clear the Fed planned to continue raising rates in pursuit of its 2% inflation target. (1) Markets initially sold off following the announcement, then bounced back up after Fed Vice-Chair Lael Brainard commented that the Fed would eventually reach a point where rate increases “create risks associated with overtightening.” The comment reignited markets’ hopes that a pause in rate increases was imminent. (2)

Those hopes were short-lived. In mid-September, new Consumer Price Index (CPI) numbers came in at 8.3%, down only slightly from 8.5% recorded the previous month. (3) The fact that inflation isn’t coming down from its elevated highs brought markets crashing back to earth. Both the Dow and the S&P 500 dropped around 4% in the days immediately following the report. (4)

Despite a calamitous September, markets managed to finish up for the quarter. But all three major benchmark indexes — the S&P 500, Nasdaq and Dow — are still squarely in correction territory for the year. And more turbulence could be looming as we enter the fourth quarter.

Source: Morningstar. Index Performance: Return (%). https://www.morningstar.com/. Accessed Oct. 3, 2022.

THE STATE OF OUR ECONOMY

Although we’ve seen a decline in the rate of inflation since June, inflation remains stubbornly high. One reason it has come down since early summer is because oil has declined from $120 per barrel to around $86 per barrel. (5)

The drop in oil prices is good news for consumers, but other staples — including groceries — continue to rise. Some decline in the price of oil is natural at the end of summer, as people end their vacations and stay around home. However, oil is a notoriously volatile commodity, and its price can shift upward at any time.

Gross domestic product (GDP) numbers for the second quarter were better than the first quarter but still dropped by 0.6%. (6) While GDP results for the third quarter won’t be released until late October, the current expectation is for GDP to remain flat. (7) Economically speaking, the U.S. has not experienced any growth this year.

There is good news. Americans are still spending, and corporate earnings haven’t been bad. However, it could be only a matter of time before consumer spending stalls and the Fed’s interest rate hikes begin to take a bite. The Fed raised rates by 75 basis points for the third time at its September meeting, and it still needs to unwind its massive balance sheet. (8) Markets seem to hate it when the 10-year Treasury gets close to 3.5% — and as of Sept. 16, it was at 3.46%. (9) The fed funds rate now stands at 3.25%, so companies and consumers will face mounting hurdles as debt service becomes more difficult and earnings (and pocketbooks) get pinched.

Paradoxically, higher interest rates could lead to lower inflation, as consumers’ dollars don’t stretch as far as they used to. Higher interest rates may also force companies to curtail spending for the same reasons, and limiting growth could lead to layoffs. The Fed has stated it is fine with a rising unemployment rate as long as it fights inflation. Generally, unemployed workers tend to spend less. These steps might be what it takes to fight inflation, but they could also drive us deeper into recession.

LOOKING AHEAD

The combination of slow economic growth and elevated interest rates will likely lead us into a period of “stagflation,” which could lead to pain for the U.S. as we head toward 2023. Mid-term elections will likely contribute to ongoing market volatility, while high energy prices may cause consumers to shut down their spending for the winter. Continued tightening by the Fed could also cause concerns for markets, especially since they haven’t been able to read the Fed properly to this point.

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Resources

(1) Rachel Siegel. The Washington Post. Aug. 26, 2022. “Markets sink after Powell says fighting inflation will cause ‘some pain.’” https://www.washingtonpost.com/business/2022/08/26/fed-powell-jackson-hole/. Accessed Sept. 15, 2022.

(2) Neil Irwin. Axios. Sept. 7, 2022. “Fed’s Brainard: There’s a risk of raising rates too much.” https://www.axios.com/2022/09/07/fed-brainard-rate-increases. Accessed Sept. 15, 2022.

(3) U.S. Bureau of Labor Statistics. Sept. 13, 2022. “Consumer Price Index Summary.” https://www.bls.gov/news.release/cpi.nr0. htm. Accessed Sept. 15, 2022.

(4) Christine Idzelis and William Watts. MarketWatch. Sept. 16, 2022. “U.S. stocks end lower as FedEx warning rattles investors, S&P 500 and Nasdaq book biggest weekly drops since June.” https://www.marketwatch.com/story/dow-futures-down-over-200-points-as-fedex-warning-rattles-investors-11663324823. Accessed Sept. 16, 2022.

(5) Markets Insider. “Oil (WTI).” https://markets.businessinsider.com/commodities/oil-price?type=wti. Accessed Sept. 16, 2022.

(6) Bureau of Economic Analysis. Aug. 25, 2022. “Gross Domestic Product (Second Estimate) and Corporate Profits (Preliminary), Second Quarter 2022.” https://www.bea.gov/news/2022/gross-domestic-product-second-estimate-and-corporate-profits-preliminary-second-quarter#:~:text=Real%20gross%20domestic%20product%20(GDP,the%20Bureau%20of%20Economic%20Analysis. Accessed Sept. 15, 2022.

(7) Federal Reserve Bank of Atlanta. GDPNow. https://www.atlantafed.org/cqer/research/gdpnow#:~:text=The%20GDPNow%20 model%20estimate%20for,1.4%20percent%20on%20September%207. Accessed Sept. 16, 2022.

(8) Taylor Tepper and Benjamin Curry. Forbes. Sept. 21, 2022. “September Fed Meeting: FOMC Delivers Another 75 bps Rate Hike.” https://www.forbes.com/advisor/investing/fomc-meeting-federal-reserve/. Accessed Oct. 3, 2022.

(9) CNBC. “U.S. 10 Year Treasury.” https://www.cnbc.com/quotes/US10Y. Accessed Sept. 16, 2022