The Cornerstone Investment Commentary: 3rd Quarter 2022
You would never believe it, but 2022’s third quarter began encouragingly and in line with our views on current economic conditions. While this strong rally proved to be a false start, it was still an encouraging sign of what we expect to unfold at some point down the road.
Of course, economically speaking, there seems to be no current topic other than the inflation rate. This quarter showed some positive news in meeting the Federal Reserve’s goal of bringing down this rate as both overall and ‘core’ inflation slowed significantly since June. However, it is frustrating that the effects of the war in Ukraine on energy and food prices as well as general supply chain issues – items the Fed cannot influence – remain stubborn inflation problems. Take food prices, for example, up over 11% this last year, including 1% per month in 2022. Obviously, Americans are not eating 1% more every month! So this is a supply challenge, not a problem with demand or spending levels that the Fed can change.
The Federal Reserve will not let up its interest rates hikes until such stubborn inflation rates subside. Importantly, the data shows that people’s expectations are for inflation to decline in the next year or two. This matters. And the Fed is demonstrating impressive resolve to work aggressively to make this happen.
The key to the financial market’s strong gains from early July to mid-August was the belief/hope that improving inflation news would slow further interest rate hikes. When markets rallied over 10% in such a short period, with the largest gains in areas we added to your portfolio in June, it indicated what’s likely to happen when the real recovery begins. Until then, we rely on patience and your bond holdings which have avoided 60% of this year’s fixed income declines. Keep in mind that when markets do turn, they often do so very quickly: 1/3 of the Spring 2020 pandemic recovery occurred in its first seven days!
In mid-August, financial markets again turned south seven weeks ago when it became clear that rate hikes would not slow any time soon. Ironically, there are now two scenarios that could prompt the Fed to slow down: 1) if the pace of monthly inflation continues to slow; or 2) if unemployment rises due to economic growth slowing or beginning to shrink (i.e., a recession). In fact, a mild recession now could actually be healthy for economic and market prospects over the next few years if it helps ‘reset’ the economy.
With all this in mind, we will continue to monitor all the economic events that unfold, mindful that their path is far from certain. With hopes and wishes for a warm and wonderful Thanksgiving and holiday season for you and your family, we thank you for the continuing opportunity to work with you.