2022 4th Quarter Investment Bulletin
Executive Summary
Stocks fell -4.5% during the 3rd quarter bringing the year-to-date loss to approximately -25%.
Bonds fell -4.76% during the 3rd quarter bringing the year-to-date loss to -14.5%.
Persistent inflation has the Fed aggressively raising interest rates which leads to tightening of economic activity.
Historically high stock prices have fallen in anticipation of decelerating earnings as a result of Fed action and general over-valuation.
Our process to manage through the volatility and be opportunistic has mitigated the initial downside and will ultimately be rewarded when markets eventually begin to recover.
Bear Market Territory
The downward trend of stocks continued during the 3rd quarter despite a sizeable mid-summer rally (see chart below) that eventually succumbed to the downward pressures on the market. On June 16th, with a year-to-date decline of approximately 24%, we increased stock allocations as the S&P 500 dipped below 3700. Almost immediately, stocks began to stabilize and move higher. The market wound up increasing 18% over the next two months before once again resuming declines on August 17th.
This type of extreme volatility is a characteristic of bear markets.
Guide to Buying Low Remains Intact
Fed policy action to fight rising inflation has been the big story line of the past few months and has stoked fears of recession. However, the measurable and identifiable over-valuation of stocks, particularly growth stocks, made a correction inevitable. As a result, we were generally under-allocated to equities leading into the correction and have systematically increased stocks to portfolio allocations as the sell-off deepens. It is often when the market feels most uncertain that we must lean on our porcess to be a steady hand.
Update on Valuation
There are a couple of charts below that highlight the current market valuation. The first is a chart that shows the S&P 500 in relation to earnings that has appeared in other bulletins. The chart is updated through 9/30 and shows that with the decline in stock prices, earnings growth is now higher than the S&P 500, which indicates a more fairly valued and possibly undervalued market. The second chart shows the change in the S&P 500 price to earnings ratio. On the far right hand side of the graph you can see that there has been a meaninfgul move lower in the forward price to earnings ratio.
Outlook
The outlook for markets and the economy remains challenged, but investors have priced in a lot of bad news already and valuations are now at levels that are more attractive. We will continue to allocate across the three main asset classes in use in your portfolio, stocks, hedged stocks, and bonds. As the markets ebb and flow, we are committed to remaining patient and we will stick to our long-term plan. That plan includes being incremental buyers into weakness and incremental sellers on strength (see chart below).
Moving Forward
As always, we are active in these markets and seek to provide clients with an open line of communication. Our process has worked well in this market, and we will continue to monitor and refine that process as events dictate.