Broker Check

Opportunity Amid Global Tumult

October 19, 2022

The third quarter of 2022 proved to be a disappointing sequel to the second, with markets continuing to respond harshly to persistent inflation, Fed rate hikes, and international turmoil. The S&P 500, a broad gauge of the U.S. stock market, dropped a further 4.88% in Q3, while the Bloomberg Aggregate Index, representing U.S. fixed income, declined by 4.75%, per FactSet. These quarterly drops were on top of an already difficult Q2. As seen in the chart below, the quarterly declines in the major indices extended the current peak-to-trough periods through the end of September.

Despite the gloom there has been of late, we have had some positive market action to start off Q4. The S&P 500, NASDAQ, MSCI ACWI (global developed market stocks) are up 2.65%, .97%, and 1.92% respectively in the first days of the quarter through October 17th, with the S&P 500 during this time seeing its best two-day streak since the sharp rebound in the latter part of 2020, according to CNBC. The Bloomberg Aggregate, by contrast, is down slightly by 1.33%. Is this rise in equities the start of the recovery or simply a bear market rally? It remains to be seen if these market increases gain traction. 

                On the domestic economic front, the story continues to be about inflation. While the year-over-year inflation rate for August was lower than in July, price increases continue to be a major pain point. The cost of living continues to go up much faster than the historical average, even if it is at a decelerating rate. Part of this small deceleration in inflation can be attributed to the highly volatile oil market, which saw Brent crude prices drop 19.8% since their highs in June, according to FactSet. While these declines are much appreciated at the pump, due to the volatile nature of energy prices, this small relief should not be counted on to tame inflation. A prime exhibit of crude’s sudden changes is OPEC’s October 5th announcement of a planned 2 million barrels-per-day cut starting in November, which would almost certainly help reverse crude’s recent price decline. To truly get inflation under control, larger forces need to work. On this front, we have something to be optimistic about: expectations of future inflation remain surprisingly low. The chart below, published by J.P. Morgan in their fourth quarter Guide to the Markets, shows that both consumers and professional forecasters are estimating future inflation to be right around its historical average.


                        People’s expectations of future inflation play a key role in actual inflation.  If expectations for inflation are high, a consumer is more likely to purchase something now rather than wait for the price to increase. The same logic would apply to the small business owner who is considering purchasing new equipment for her company. Why wait until prices have skyrocketed? People and businesses rushing to buy or invest now to avoid future price increases heightens inflation as demand outstrips supply. This can lead to a nasty feedback loop of inflation, the likes of which we have not seen since the early 1980s. Fortunately, at least for now, we are not seeing people’s inflation expectations rise above historical averages.

                 On the international front, the picture is far gloomier. Russia continues to wage its cruel invasion of Ukraine, with the economic knock-on effects spreading far beyond the conflict. Focusing on Europe in particular, two concerning stories have emerged. First is the mysterious Nord Stream pipeline leaks in the Baltic Sea. On September 26th, the Geographical Survey of Denmark detected two low intensity seismic events around the Nord Stream 1 and Nord Stream 2 pipelines. Analysis of their data later revealed that the activity could only have been manmade, suggesting two massive explosions as a part of intentional sabotage of the pipelines. While the pipelines were shut down at the time of the explosions, there was still residual gas inside them, leading to an estimated half a million metric tons of methane leaking, the largest in history, according to the Associated Press. While there is no official pronouncement on the culprit, Western officials largely pin the blame on Russian agents. Regardless of the perpetrator, the attack again highlights Europe’s crippling vulnerability to energy shocks. 

                The United Kingdom presents a second concerning episode. On September 23rd, the nascent government under Prime Minister Liz Truss released a sweeping economic plan to cut taxes on high-income earners and corporations, financed by debt issuance, to stimulate growth in their struggling economy. Unfortunately for the government, international investors spooked by the inflationary implications of this were none too pleased, selling Pounds at such a clip that the UK’s currency fell to an all-time low of $1.0382 per Pound by September 25th. The government eventually scrapped this proposal in an embarrassing about-face, but this illustrates how markets are extremely averse to even the hint of policies that could exacerbate inflation.


                        These two events paint a picture of the vulnerability Europe faces as it fights inflation, energy shortages, and a war within its borders. While Europe certainly is not the only market in the world, it is a major component of it, and is representative of the hardships other regions are facing. Stock prices outside the U.S. reflect these challenges, with the chart here provided by J.P. Morgan showing that the MSCI All Country World Ex US Index has a Price-to-Earnings ratio 28.8% lower than the S&P 500. This suggests that the market places a steep discount on non-U.S. equities during these turbulent times.

                         While market and geopolitical tumult is concerning, now is the absolute worst time to get emotional while investing. This is far easier said than done, but the data drives home the importance of staying the course when sentiment is poor. Below is another chart from J.P. Morgan’s fourth quarter Guide to the Markets, this time showing returns and consumer sentiment. In short, during the eight lowest periods of consumer sentiment, the following 12-month S&P 500 returns averaged 24.9%, while the following 12-month returns during the 8 highest periods of consumer sentiment averaged only 4.1%. While past performance is no guarantee of future results, history has shown that the even-tempered investor who stands firm during stressful periods is often rewarded.


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