Hey, what’s going on with markets?
I’ve got some thoughts to share.
Just a few short 30 days ago, we experienced the broad-based markets in rally mode and the thought of this summer’s selloff may finally be coming to an end. Not so fast, the markets had different plans in store. Just before the Fed was about to announce another 75-basis point interest rate hike, higher-than-expected inflation data slammed investor expectations and more volatility rippled through markets, causing a broad selloff.1
Now, the market, who I’m referring to as Jekyll and Hyde this year, after seeing a few Central Banks change course has hit a rally mode once again. This continues to prove our thoughts from earlier this year, volatility will remain king for the foreseeable future.
Want a deeper dive into what’s going on and what could happen next? Keep reading.
(If not, scroll down to my P.S. for something delightful.)
Why are markets selling off?
Folks were hoping that tamer inflation would cause the Federal Reserve to pull back on its interest rate hikes. But inflation data was a little higher than anticipated, and unfortunately, any inflation surprise to the high side means the Fed is likely to continue aggressive rate hikes in the months to come. This spooked investors who expected a pivot away from higher rates.
When the Fed sets higher interest rates, it increases the cost of credit across the entire economy, making mortgages, car loans, credit cards, business financing, etc. more expensive. I also encourage everyone to think a little on how inflation started. We had massive government spending coupled with supply chain disruptions. This created too much money chasing too few goods, pushing prices higher. Anyone who has taken Economics 101 will remember this, if nothing else from their textbooks.
Did this occur immediately as the government pushed out PPP Loans and various stimulus checks and programs? Certainly not, it took time. Just like after the Fed started to raise interest rates in January, did the pace of inflation immediately slow? No, but we can see pace of inflation is slowing some 9 months after the initial rate hikes.
Investors worry that those higher rates will slow the economy and possibly tipping it into recession. This may ding company earnings and impact stock market performance. According to FactSet, current year 2022, analysts are predicting earnings growth on the S&P 500 of 8.9%. So even as company profits have grown on average, the market has seen a significant selloff. Some say the market has already priced in fears of a recession and actual slowdown in the economy. Time will tell if we see an actual recession with increasing unemployment rates, falling wages, and decreasing company earnings. Stay tuned to find out in early 2023.
What could be the longer-term impact of rate hikes?
Whenever we want to understand what could happen, it’s useful to go back in time and take a look at what’s happened before. While the past can’t predict the future, it’s often a useful guide.
An analysis of 12 previous rate hike cycles shows that, overall, equity markets handled tightening reasonably well. Across these cycles, the S&P 500 averaged a total return (including interest, dividends, etc.) of 9.4%.2
So, what can history teach us?
- Stocks tended to take rate hikes in stride over time.
- However, those historical gains didn’t come in a straight line. They included dips, shocks, selloffs, and bear markets. They even included a few recessions.
- Folks who bailed on the ride down probably missed a lot of the ride back up. Think back to my rollercoaster ride scenario a few letters back.
- Predictions are a murky business. While what happened in the past is useful to a point, it’s not a map of the future. History may not repeat itself, but it may rhyme.
What’s the bottom line?
I think more volatility is in the cards in the days and weeks ahead. As investors digest the Fed decision, economic data, and Q3 corporate earnings, we’re going to see some reactions, positive and negative. Much like what we’ve experienced most of this year. However, I don’t think it’ll all be gloom and doom. I think markets are overreacting and forgetting that there’s a lot of uncertainty and margin for error in economic data.
Statistical agencies must walk a thin line to get data out quickly (so it’s useful to decision makers) while being transparent about how much error is baked into their estimates.
Bottom line, I’m keeping an eye on markets and the economy, and will be reaching out with more insights as I have them. I’m not buying into a hard economic landing just yet. My guess is the Russian/Ukraine war is closer to the end than the beginning, we will have far less interest rate increases vs. what we’ve seen thus far, inflation worries will most likely become deflation concerns, and the market is more fairly priced today than it was at the start of January.
Before I sign off, I’d like to ask: how are you doing? What are you looking forward to this fall? Email or call me and let me know. For my family, we’re heading off this weekend to my Godchild’s Wedding and looking forward to celebrating with family. I love watching the leaves change colors, the cool morning and nights, and weekends jammed packed with football.
Enjoy the upcoming weekend,
Jeremy Ftacek, AIF®
Ftacek Financial Services, LLC.
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