Jayson Moss, CFA
Chief Investment Officer
U.S. markets continued to struggle in the third quarter of 2022 on the back of weak returns posted during the first half of 2022. All told, equities posted their third consecutive quarterly loss, with the S&P 500 down 23.8% for the first three quarters of the year, placing the index at its lowest level since 2020. The Dow Jones Industrial Average (DJIA) and NASDAQ Composite Index are also at their lowest levels since 2020 with the DJIA and Nasdaq Composite declining 20.9% and 32.4%, respectively, in 2022. Similarly, fixed income has not fared much better as a rising interest rate environment has placed downward pressure on these securities. The iShares Core U.S. Aggregate Bond ETF, which broadly tracks U.S. investment-grade bonds, is down 16% year to date and is down 5.3% for the third quarter.
In addition, during the third quarter, the S&P 500 Total Return Index declined 4.8%. This decline compares to the NASDAQ Composite Index which declined 4.1% for Q3 2022. Outside of the U.S., equities were also soft. As represented by Europe, the Middle East and the Pacific, the MSCI EAFE Index was down 10%, while in Canada the S&P/TSX Composite Index decreased 2.2%.
Inflation remains a key concern as it continues to run at a pace close to a four-decade high. For the month of August, the Consumer Price Index increased 8.3% compared to August 2021. On a month-over-month basis, consumer spending rose 0.4% in August, with real, inflation-adjusted spending up 0.1% over the same period. In Europe, eurozone inflation hit 10% in September, which is its highest rate since records began to be kept in 1997. Inflation has been relentlessly high despite the easing of certain costs. While supply-chain issues continue to result in shortages, some bottlenecks have started to abate. Additionally, certain commodity prices have retreated from their highs during the pandemic, in some cases returning close to pre-pandemic levels. In fact, crude oil futures (NYMEX) closed out the third quarter at US$79.49 per barrel, representing a 24.8% quarter-over-quarter decrease. Conversely, natural gas futures (NYMEX) increased 24.7% to US$6.77 per MMBTU. Other notable commodities include lumber, which is down 75% from its peak in May 2021 and back to prices last seen in the first half of 2020 (CME random length lumber futures), and copper, which is back to Q4 2020 levels and down 30% from its high in February 2022 (COMEX copper futures).
Persistently high inflation has caused central banks globally to continue their hawkish stance towards monetary policy. In the U.S., the Federal Reserve is raising interest rates at its fastest pace in forty years. The Fed raised rates by 0.75% for the third consecutive time in late September, which placed the benchmark fed-funds rate in a band of between 3.0% and 3.25%, a level not seen since 2008. Central banks in Europe and Canada have also pursued similar strategies to tame inflation.
In an effort to combat inflation and bring it under control, the U.S. central bank has committed to continue to raise rates, potentially putting economic growth at risk and possibly pushing the economy into recession. The Fed has been adamant that it will continue to fight inflation until it reaches its 2% target, at the expense of the economy and employment in the near term. Despite higher rates, real consumption (adjusted for inflation) increased in July and August, putting spending on track for eight consecutive quarters of growth. That said, higher rates should have implications on spending at a certain point. In fact, mortgage rates hit 6.7% (a level not seen since July 2007), and average interest rates on car loans hit 5.7% in the third quarter of 2022, a three-year high.
Furthermore, the personal savings rate was 3.5% in August, which down from 9.5% in the same period of last year and at levels reminiscent of the Great Recession (2007-2009). One of the culprits of the current inflationary predicament has been higher savings accumulated during the pandemic, with consumers spending savings on goods that were in scarce supply. With higher borrowing costs, lower savings rates and more readily available goods, the supply-demand imbalance should eventually normalize and bring inflation towards the Fed’s 2% target.
A higher interest rate environment has direct implications on all asset prices. The higher the interest rate (or discount rate), the lower the value of the future cash flows of the asset today. As interest rates continue to rise, this movement will place downward pressure on equities, bonds and other hard assets, such as real estate, broadly speaking.
While we remain mindful of the potential for continued pressure on asset prices as well as for a potential recession, Evolve Wealth Advisors does not attempt to time the market. Given our long-term approach to investing, we are ready to capitalize on near-term market dislocations that present attractive investment opportunities on both a relative and an absolute basis. Over the long term, we remain confident that the U.S. and other developed market economies will drive economic growth.
With this favorable long-term outlook in mind, we remain positive on equities, particularly given the meaningful pullback in valuations over the course of the year and the ability of certain companies to compound their earnings over the long term. Additionally, we are incrementally more positive on fixed income given the higher rate environment. That said, we believe that downside risk remains present as there is an increased probability of a higher interest rate environment, as well as wider credit spreads, should the economy enter a recession.
To learn more about Evolve Wealth Advisors, please visit our website at www.evolvewealthadvisors.com. Should you have any questions regarding your account or how Evolve Wealth Advisors can help with your future Estate or Retirement planning needs, please contact Peter Henry, CEO at 818-970-6940 or Patrick Kinney, COO at 503-490-0273.
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