September was a difficult month for investors as almost every asset class dropped in value. US Equity benchmarks are down between 25% and 35% off their 52-week highs. Bond prices dropped and fixed income yields rose as the Federal Reserve continued its hawkish stance on interest rate policy. At the beginning of this year the markets priced in three 25 basis point increases to the Federal Funds rate in 2022 with an expected overnight rate to be approximately 75bps.

Currently, the market is pricing that rate to be over 4.00% by year and 4.50% by mid-2023. Central banks around the world are now being forced to rapidly increase interest rates to combat skyrocketing inflation.

Higher interest rates have a greater negative impact on growth stocks, as they tend to be more levered. Additionally, their earnings projections are further in the future making their revenue stream more susceptible to higher inflation. This is evidence by the year-to-date results in the graph below.

Energy pressures, a tight labor market and rising input costs continue to weigh heavily on inflation. The year-on -year CPI (Consumer Price Index) is now 8.30%. This number is lower than the 9.00% reading in June but is still well above the Federal Reserve’s comfort level.

As we have mentioned in the past, the Federal Reserve’s primary tool to combat inflation is monetary policy. The Federal Reserve increases the rate they charge to banks for overnight loans in the hope banks will then pass along this increase to their customers. In theory this rate increase will slow down borrowing which in turn will slow down demand, thus cooling off an overheated economy.

It is important to recognize that anticipated interest rate moves are priced into the market. Today’s overnight rate of 3.125% is projected to be close to 4.50% by mid next year. The market reacts based on changes to the projection, not to the actual move itself. The 75-basis point increase in September was fully priced into the market. The negative reaction in both stock and bonds after the announced rate increase was the result of hawkish comments from the Fed Chairman in his Q&A. Citing prolonged CPI readings, the Chairman alluded to added rate hikes in 2023 which triggered the sell-off.

Higher rates often lead to opportunity. CD’s, corporate bonds, and municipal bonds now offer yields we haven’t seen in close to 15 years. The landscape for fixed income investing offers attractive returns compared to a year ago. The chart below compares yields of US Government Bonds from September of 2021 to September of 2022

Corporate Bonds offer yield 100-200 basis points higher than the US Treasury yields listed above.  Cash can now be invested at appreciably better rates.

With higher rates comes a stronger USD.  The dollar index has gained almost 17% YTD, on record to be its best year in over 50 years.  A strong dollar is great for those traveling abroad but puts added pressure on other countries that purchase goods and services from US.  The cost to import from the US is now significantly more expensive for other countries.  Economists are keeping a keen eye of trade flows as this could lead to a slowdown in domestic economic activity.

As we mentioned in our previous newsletters, short term volatility has little impact on long term investment results. A well-diversified balance portfolio is a time-tested strategy for long term capital. This market volatility is common. 

As always if you have any questions feel free to reach out.

Best,
Bob

Opinions are those of the author and not necessarily those of Guardian or its subsidiaries

The S&P 500 Index is a market index generally considered representative of the stock market. The Index focuses on the large-cap segment of the U.S. equities market. The Hang Seng Index (HSI) is a market-capitalization-weighted stock market Index in Hong Kong.  It is used to record and monitor daily changes of the largest companies of the Hong Kong stock market and is the main indicator of the overall market performance in Hong Kong.

Indices are unmanaged, and one cannot invest directly in an index. Past performance is not a guarantee of future results. All investments contain risk and may lose value. Investing in the bond market is subject to certain risks including market, interest rate, issuer, credit, and inflation risk. Equities may decline in value due to both real and perceived general market, economic and industry conditions.

Statistics sources from Central Bank Rates, Bloomberg, US BLS and Pew Research

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