· Volatility in the stock market continued this past week as a massive rally on Thursday reversed itself on Friday leading most major indices to close lower for the week. All of the talk on the financial networks Thursday was a discussion over whether or not the bottom of the bear market had passed. That discussion quickly reversed itself on Friday, as pundits then focused as to how much downside was left. Our view on the financial markets is that we are in a trading range at best and there is no need to rush in to buy stocks or bonds for that matter. That said, we would certainly not recommend selling either as equities historically provide the most efficient way to accumulate wealth over a full economic cycle.
· The volatility noted above was due in large part to a continuation of the sticky inflation figures, prompting many to suggest that Fed policy will remain tighter for longer. Prices at the retail level as measured by the Consumer Price Index (CPI) were released this past Thursday and showed inflation still running hot. For example, the cost of food, shelter and energy services rose 0.8%, 0.7% and 1.1% during the month of September and by 11.2%, 6.6% and 19.8% over the past year. It is important to note that shelter costs represent nearly one-third of the overall CPI. Energy slumped 2.1% during September, but has risen 19.8% over the past twelve months.
· Earnings season begins in earnest this coming week (see below). Rather than the past quarter, much of the focus of investors will be on the forward guidance along with the drag that the double digit rise in the dollar over the past year has had on multi-nationals. In addition to this, the response of investors to the reports will be a telling sign as to how much of the impact of the economic slowdown has been already priced into the shares.
· The yield on the 10-Year U.S. Treasury Note closed above four percent for the first time since October 2008, closing at 4.005% Friday. On Thursday, the 10-Year traded at an intraday high of 4.0775% before settling back to close at 3.952%.
· Although we agree that the debt to Gross Domestic Product (GDP) ratio is historically high and of concern over the intermediate to long-term, the short-term impact has yet to be felt. This is evidenced in the rise of the dollar relative to other currencies. Where the short-term trouble may occur pertains to emerging market debt.
· For those receiving Social Security, benefits, as a result of the rise in inflation over the past year as measured by the Consumer Price Index (CPI), expect an 8.7% increase in benefits beginning in January 2023. Please note that this cost of living adjustment will also apply for those under the Civil Service Retirement System (CSRS) as well as those under the Federal Employees Retirement System (FERS). Should the Fed be able to bring inflation under control, real, inflation adjusted income gains will occur.
· According to Freddie Mac, the interest rate on the 30-Year Mortgage closed at 6.92%, the highest since April 2002. When compared to one year ago when that same rate stood at 3.05%, it is easy to see how the housing market has turned lower. For example, the interest paid during year one of a $300,000 30-year mortgage has risen by $11,610 or $967.50/month.
· The Dow Jones Transport Average (^DJT) comprised of the airlines, rails and truckers outperformed the broader averages for the third consecutive week. Although the correlation with the broader economy is not what it once was, the recent relative outperformance of this industry is something to watch.
· As noted above, the interest rate paid on the U.S. 10-Year Treasury Note continues to climb, rising from 3.89% to 4.00%, its highest level in more than a decade. At the close of 2021, the interest paid on that same note was 1.52%. In dollar terms, $100,000 invested will now pay interest of $40,000 until maturity as compared to $15,200 as of last December, welcome news for savers.
· Welcome to the fourth quarter. Please note that for clients with non-qualified accounts, when beneficial, Fagan Associates will begin tax loss harvesting through realizing unrealized losses to include sales into cash, sales and waiting thirty days to avoid the wash-sale rule or swaps to similar but not exact securities (for example, FedEx to UPS). Given the rise in interest rates, when appropriate we will also take a similar course of action with fixed income.
· Housing data will be the focus this week in regard to economic data being released. Of particular note is – on Tuesday, September Industrial Production & Capacity Utilization; on Wednesday, September Housing Starts; on Thursday, the Weekly Report of Initial Claims for Unemployment Insurance, Existing Home Sales and the Index of Leading Economic Indicators.
· Earnings season is upon us. We are expected weaker than expected earnings. However, we will pay particular attention to the forward guidance as well as investor reaction to the reports. Of note are reports from Bank of America (BAC), Charles Schwab (SCHW), Johnson & Johnson (JNJ), Lockheed Martin (LMT), Netflix (NFLX), Goldman Sachs (GS), Intuitive Surgical (ISRG), Tesla (TSLA), Elevance Health (ELV), International Business Machines (IBM), Procter & Gamble (PG), Abbott Labs (ABT), ASML Holdings (ASML), Phillip Morris (PM), Union Pacific (UNP), Danaher (DHR), AT&T (T), American Express (AXP) and Verizon (VZ).
· LONGER-LASTING ISSUES TO KEEP AT TOP OF MIND
o The headline story that will continue to impact Western Europe as well as the global economy pertains to the Nord Stream 1 pipeline. This pipeline, owned by Gazprom, Russia’s state operated energy company supplies more than 40% of Western Europe’s total energy consumption. According to Russian President Vladimir Putin, should the G7 (United States, France, Italy, Japan, Canada, Germany and the United Kingdom) institute price caps on Russian oil, it would leave Russia with only one alternative and that would be to “not supply anything at all if it contradicts our interests. We will not supply gas, oil, coal, heating oil – we will not supply anything.” However, the price cap will most likely fail unless the two largest purchasers of Russian oil, India and China agree to the cap. As of now, they have not. For Europeans, it may presage a long, cold winter. Once again, should the war in the Ukraine continue, the continued “weaponization” of Russia’s natural resources is likely.
o We are excited about the recent rise in the yield on fixed-income securities, especially U.S. Treasuries. With yields above three percent all along the curve, should the Fed succeed in reigning in inflation without inflicting too much long-term damage on the economy, real returns on treasuries will turn positive. This will provide conservative investors with a viable alternative to equities and allow them to reduce portfolio risk.
o We liken the aggressive policy of the Fed to rain. The ground (economy) can absorb a couple inches of rain over an extended period of time. However, it cannot absorb it over an hour or two. We believe that after this upcoming hike it would behoove the Fed to pay more than just lip service to their claim of data dependency or once again, run the risk of cooling off economic growth more than what is needed to quell inflation.
o Unlike the past couple of bear market where investors witnessed a V-shaped bottom, this should be more of a “U,” or a process rather than an event. Not to worry, as we believe this bottom will usher in a new, longer-lasting, more durable bull market, one in which the Fed will not be the center of attraction. However, prior to that, we will need to see inflation ebb and the Fed pivot.
o The yield curve (the difference between the yields on different maturities of the identical securities, in this case U.S. Treasuries) has continued to invert in a meaningful fashion. The curve, historically a predictor of an economic slowdown, measures the relationship between like bonds of different maturities. In fact, an inverted yield curve has predicted every recession since 1955. That said, it has also predicted recessions when one did not occur. This past week, the yields on the two- and five-year Treasury Notes were inverted or higher when compared to the ten-year U.S. Treasury Note at 4.48% and 4.25% versus 4.00%. Many market pundits will point to this as evidence of a looming recession. At this time, a technical recession brought about by the Fed raising interest rates is likely, the depths of which are most likely shallow as it will not have been caused by a collapse in the credit markets a la 2007-early 2009.
o Keep in mind that the stock and bond markets are anticipatory in nature, historically moving six to nine months ahead of the confirming data. It is precisely for this reason that investors hoping to “buy when things look better” never get the chance to do so. Unfortunately, by the time the economic data turns for the better, stock prices have already taken this into account. For example, during the pandemic, the stock market bottomed on March 23, 2020, just as the economy was shutting down. Three months later stocks had risen forty percent!
o A component to traditional, longer-lasting bear markets is the emotional strain it places upon the investor. Just as bull markets place pressure on investors sitting on the sidelines, bear markets exert the same force on those that have money in the market. Should the market remain choppy as we believe it will at least throughout the summer, you can count on a steady drumbeat from talking heads questioning the validity of long-term investing. We have regularly noted that unlike recent pullbacks, the recovery from this one will most likely be more of a process rather than an event and would recommend our clients to ignore the short-term and focus on your long-term objectives.
o The Fed has become too important in regulating the economy. Hopefully, when this is over, we can get to a more normalized economy with less overt Fed intervention. Recessions are necessary as they bring back into balance supply and demand. In addition, vis a vis creative destruction, recessions revitalize the economy, positioning it for a new era of growth.
o We continue to monitor the returns of the Vanguard Balanced Index Fund (VBAIX) to illustrate the extent of the selloff even in balanced accounts, including the bond market. VBAIX, somewhat of a proxy for balanced investors has fallen 21.23% through the close of business Friday, as in addition to the pullback in stocks, bonds, which comprise nearly 40% of the portfolio, have been under pressure. For example, the Vanguard Total Bond Market Index Fund (VBMFX) has fallen 15.84%. In fact, even the Vanguard 2020, a mutual fund designed for “investors planning to retire or leave the workforce in or within a few years of 2020 (the target year)” has dropped 18.83% ytd.