Contributors: Andrew Walker, Bruce Ensrud, Matt Stockman
THE SHORT STORY
The market has been humbled so far this year by ongoing inflation concerns and the Federal Reserve’s response. Volatility should continue as the market reacts to corporate earnings falling short of the record-setting year that Wall Street is currently forecasting due to margin pressures.
All that said, we do not see things as being overly dire. The economic backdrop is very strong and should allow us to weather impacts from the Fed’s actions, inflation, and any economic hiccups in a resilient manner.
While we cannot predict when, exactly, the market will bottom (studies show that trying to do so is futile), there is a great case to be made that we are at, or at least near, a great market entry point. To quote Warren Buffett, “Be fearful when others are greedy, and greedy when others are fearful.”
Where We’ve Been – 2022 Q2 Review
Markets have been turbulent thus far this year. Excessive stimulus and supply chain issues stemming from Covid both stunted supply and turbo charged demand – a recipe for inflation. Wary of upsetting the market’s apple cart, the Federal Reserve started talking about rate hikes in Q3 2021 but did not actually get around to acting until March 2022, when it was already painfully obvious that inflation was not “transitory”.
When the Fed began signaling to markets in January 2022 that it intended to hike rates higher and faster than it had initially indicated, markets repriced downwards – and quickly. The inverse relationship that bonds have with interest rates sent bonds plummeting. Stocks took a nosedive as well, given that the discount factor used to value stocks is derived from interest rates (and a higher discount factor = lower valuations/prices).
Since rate hikes began, the world has been somewhat upside down, with good economic news being bad for markets (strong economic data gives the Fed more cover to hike rates, implying “more damage to come”), and bad economic news being good for markets (bad economic data indicates the Fed may stop tightening, implying “damage has already been done”). Of course, the Russia-Ukraine conflict has only served to exacerbate the inflationary issues facing the Fed (and increase market fears that the Fed will hike the economy into a recession).
Second quarter and year-to-date returns, as shown below, are sharply negative outside of the US Dollar, which has benefitted from the Federal Reserve raising rates faster than other central banks around the world, and the fact that the economic recovery in the US has been stronger than that of other international economies.
| Market Category | Market Index | Q2 2022 | YTD 2022 |
|---|---|---|---|
| US Large Cap | S&P 500 | -16.1% | -20.0% |
| US Small Cap | Russell 2000 | -17.5% | -23.9% |
| International Developed | MSCI EAFE | -14.3% | -19.3% |
| Emerging Markets | MSCI Emerging Markets | -11.4% | -17.6% |
| US Bonds | BB US Aggregate | -4.7% | -10.3% |
| US Dollar | DXY* | +6.5% | +9.4% |
Where We’re Going – 2022 Q3 Outlook
The cat and mouse game that the Fed is playing with inflation will continue to impact markets. As part of this, the artificial volatility suppressing distortion that the Federal Reserve has created in markets for the last ~15 years will begin to revert, ultimately making a case for a new normal of higher volatility.
Aside from the Fed, we expect corporate earnings to start to play a bigger role in market returns. Current expectations are for record earnings this year and next year. Faced with rising input costs, wage pressures, and waning economic stimulus, achieving record earnings seems unlikely. Headlines are already showing signs of stress – layoffs, hiring freezes, inventory build ups, strong dollar, etc. Ultimately, we expect profits to be positive, but to fall short of expectations (or for analyst expectations to be adjusted downward). When markets digest the reality of this, there could be more downside volatility.
Despite this gloomy outlook, and the fact that we are likely already in a technical recession (two quarters of economic contraction), we do not see things as being overly dire. The consumer is strong (excess savings, strong labor market), corporate balance sheets are relatively unlevered, and the overall economic backdrop is healthy (albeit slowing). Given this, we believe that any recession will prove to be mild and have relatively benign effects on the average individual. Because the recessions that people remember are the more severe ones, it is often forgotten that recessions are a normal (dare we say “healthy”) part of the economic cycle…growing, getting rid of excess, and repeating….
While we cannot predict when the market will bottom (studies show that trying to do so is futile), there is a great case to be made that go forward returns will be strong.
- Valuations have moderated substantially, improving go forward return expectations
- Historically, large drawdowns are followed by periods of strong returns
- Consumer Sentiment, a contrarian indicator, is at 40-year low
- Markets bottom before economies bottom, and peak before economies peak
- Cash on the sidelines is losing badly to inflation in this environment
Although we are at or near a great entry point to invest, there remains much uncertainty in markets. Therefore, it is important to emphasize that our main conviction is that market exposure today should be rewarded over the next 1-2 years. Because of the remaining uncertainty, we are focused on attaining exposure through allocations in more defensive areas of the market that will be more resilient through remaining volatility while still offering very attractive upside potential when the bear market ends.
Thank you for allowing us to partner with you as we navigate the ever-changing market. We appreciate your continued trust.
If you have questions or would like to dive deeper into this quarter’s outlook, please reach out to our investment team. We’d be happy to set up a virtual coffee to talk more.
Advisory Persons of Thrivent provide advisory services under a practice name or “doing business as” name or may have their own legal business entities. However, advisory services are engaged exclusively through Thrivent Advisor Network, LLC, a registered investment adviser. Parable Wealth Partners and Thrivent Advisor Network, LLC are not affiliated companies. Information in this message is for the intended recipient[s] only. Please visit our website parablewealth.com for important disclosures.
Different types of investments involve varying degrees of risk. Therefore, it should not be assumed that future performance of any specific investment or investment strategy will be profitable.
Asset allocation may be used in an effort to manage risk and enhance returns. It does not, however, guarantee a profit or protect against loss. Performance of the asset allocation strategies depends on the underlying investments.
This website is intended to provide general information about Parable Wealth Partners and its services. It is not intended to offer or deliver investment advice in any way. Information regarding investment services are provided solely to gain an understanding of our investment philosophy, our strategies and to be able to contact us for further information.
Market data, articles and other content on this website are based on generally available information and are believed to be reliable. We do not guarantee the accuracy of the information contained in this website. The information is of a general nature and should not be construed as investment advice. Please remember that it remains your responsibility to advise Parable Wealth Partners, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services.
We will provide all prospective clients with a copy of our current Form ADV, Part 2A (“Disclosure Brochure”) and the Brochure Supplement for each advisory person supporting a particular client. You may obtain a copy of these disclosures on the SEC website at http://adviserinfo.sec.gov or you may Contact us at team@parablewealth.com to request a free copy via .pdf or hardcopy.
This material is provided for informational purposes only and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The views and strategies described may not be suitable for all investors. They also do not include all fees or expenses that may be incurred by investing in specific products. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. You cannot invest directly in an index. The opinions expressed are subject to change as subsequent conditions vary. Advisory services offered through Thrivent Advisor Network, LLC.
This communication may include forward looking statements. Specific forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts and include, without limitation, words such as “may,” “will,” “expects,” “believes,” “anticipates,” “plans,” “estimates,” “projects,” “targets,” “forecasts,” “seeks,” “could’” or the negative of such terms or other variations on such terms or comparable terminology. These statements are not guarantees of future performance and involve risks, uncertainties, assumptions and other factors that are difficult to predict and that could cause actual results to differ materially.
Index Benchmarks presented within this report may not reflect factors relevant for your portfolio or your unique risks, goals or investment objectives. Past performance of an index is not an indication or guarantee of future results. It is not possible to invest directly in an index.
The Bloomberg U.S. Aggregate Bond® Index, or the Agg, is a broad base, market capitalization-weighted bond market index representing intermediate term investment grade bonds traded in the United States. Investors frequently use the index as a stand-in for measuring the performance of the U.S. bond market.
The MSCI EAFE® Index is a broad market index of stocks located within countries in Europe, Australasia, and the Middle East.
The MSCI Emerging Markets® Index is a selection of stocks that is designed to track the financial performance of key companies in fast-growing nations.
The Russell 2000® Index measures the performance of the 2,000 smaller companies that are included in the Russell 3000® Index, which itself is made up of nearly all U.S. stocks. The Russell 2000® is widely regarded as a bellwether of the U.S. economy because of its focus on smaller companies that focus on the U.S. market.
The S&P 500® Index, or the Standard & Poor’s 500® Index, is a market-capitalization-weighted index of the 500 largest U.S. publicly traded companies.
The U.S. Dollar Index – known as USDX, DXY, DX and USD Index – is a measure of the value of the United States Dollar (USD) against a weighted basket of currencies used by U.S. trade partners. The index will rise if the Dollar strengthens against these currencies and fall if it weakens.