Q3 2022 Market
Commentary

At any given time, there are seemingly endless global issues impacting financial markets. We will focus this commentary on what we believe the most imminent and pressing threats are today. Specifically, inflation and the impacts of future actions of the Federal Reserve. This is not to discount the several geopolitical risks present in society today. Most recently, the Taliban takeover of Afghanistan and the escalating border crisis in Texas have brought newfound political unrest. But based on the most recent decade, the market has looked through these types of geopolitical issues. Discounted as temporary problems, with investors instead choosing to focus on economic numbers and growth prospects to drive investment decisions. Time will tell if these political risks materialize in the markets. But for now, inflation and interest rates have our greatest attention.

Inflation is the result of increasing prices for goods, or inversely, a decline in the purchasing power of your money. Historically, 3.2% is the average annual rate of inflation, based on the Consumer Price Index (CPI). In the recent September release, CPI came in at 0.4%, up 5.4% from a year ago and up from the 0.3% posted in August. Looking back at August, CPI came in below expectations, partly due to one-off sectors that the Delta-Variant may have influenced. Specifically, transportation services pricing was down -2.3% in August, and Airline prices were down -9.1%. These sectors are directly impacted by the increased delta-variant covid-19 cases and should reverse ship quickly as cases fall and vaccination rates increase. Putting the official data aside, it has also become apparent to the “eye test” that prices on food, gas, materials, rent, and more have risen rapidly, and inventories are low. A few notable price increases over the summer (June-September) include- Gasoline up +8.9%, Used Cars up +8.5%, and Food at Home up +3.1%. These numbers certainly have the general public’s attention and bring the inflation discussion to the forefront. But does this inflation matter for the market and your investment portfolios? Potentially. One of the biggest threats from inflation is to stocks. But it takes inflation above and beyond expectations and realized growth to have a negative impact truly. Collective efforts are being made to ease inflationary pressure, such as the recent announcement that the Port of Los Angeles will begin operating 24/7 to address supply chain issues.

As inflation rises, companies with significant pricing power (holding the ability to pass along increased input prices to the consumer) tend to outperform growth stocks. As we’ve mentioned throughout this year, we have been gradually increasing allocations to value and pricing-empowered sectors like industrials, durables, and actual materials companies. In doing so, our bar-belled approach to owning both growth and value sectors in equities is positioned for the foreseen, digestible inflation levels.

Despite the current inflationary period, some auto-stabilizers are at work in the market to keep the engine running. One of the most important right now is continued earnings growth. Stock growth, in theory, is a function of a company’s ability to earn money, reinvest it, and redistribute it to the shareholders. Current estimates point toward 44% growth for the full year 2021, an astounding number. So as inflation creeps up, earnings growth should continue to tamper the adverse effects on equities and even aid in what we believe will be a continued period of growth ahead in the market. The market can absorb predictable inflation, and we will continue to monitor how it evolves as we head into the final quarter of 2021.

The second mentioned hazard ahead is what the Federal Reserve is planning. When the Covid pandemic first began, the government jumped into action, and the central bank pulled all the levers they could to enact easy-money policy. One of the Fed’s most used tools is adjusting their balance sheetand explicitly buying treasury bonds in the open market. This has recently been to the tune of billions of dollars of treasury bonds and mortgage-backed securities. The result is a wave of money flushed into Q1 2021 Market Commentary circulation (a contributor to inflation), allowing the Fed to keep interest rates near zero, which in turn encourages borrowing, spurs business investment, home buying, and overall economic growth. A great tool to have. The problem is, they cannot do this forever. Eventually, the Fed will need to “taper” or slow down their treasury bond purchases.

Fed Chairman Jerome Powell has pointed toward this beginning as soon as November and concluding in mid-2022. The market typically does not react well to this. Market participants love an “easy-money environment” as it increases sentiment and typically boosts stock prices. It takes a period of resounding economic strength for tapering and rising interest rates to be received well. In general- the longer the Fed remains accommodative, the more likely for the bull market to continue. It has become increasingly difficult during this period for the Fed to find a “good time” to begin tapering. After all, we are still 5.5 million jobs short of pre-Covid levels, and with all the other external threats out there, it is our opinion the Fed will be forced to remain accommodative for longer than planned. If this is the case, aside from additional unforeseen circumstances, it will help near-term growth in the market continue.

As we look to continue navigating the current market environment, we proceed with our stance of cautious optimism. Earnings growth, a peak in Delta cases, and a soft landing for interest rates and inflation are what we are looking for, but we are always ready to adjust accordingly as needed. We welcome any thoughts or opinions on the current landscape and look forward to speaking with you all this coming quarter