2022 Q3 Market
Commentary

2022 has been a harsh environment to navigate as stocks and bonds have fallen sharply off their highs in the face of spiking inflation, aggressive interest rate hikes, and deteriorating economic data. We see more challenges ahead but are focused on near-term catalysts for relief and long-term opportunities created by the dislocation. In the near-term, inflation numbers are likely to level off or even slow toward the year’s end. In turn, we anticipate an aggressive (yet potentially temporary) bounce off market lows in equities and a rally in bond prices. How the Fed responds as inflation shows signs of stabilizing will determine if the market can sustain a rebound. Regardless of the near term outcome, downside risk remains ever-present.

Headwinds include additional rate hikes, political unrest approaching midterm elections, and continued geopolitical threats from Russia, China, and North Korea. We will remain defensive while making small tactical portfolio changes and continuing tax loss harvesting as opportunities present themselves in the market.

• We are no longer in a zero-interest rate environment. 1-year, 2-year, and 5-year rates are all above 4%*
• Treasuries are one of the safest places to hold cash while waiting for markets to stabilize.
• As an example, the 2-year Treasury yield is above 4% for the first time in the last decade (chart below)

*Source: Chart & Rate Data: Bloomberg L.P

• Default rates remain historically low (see chart below)
• Corporate issuers are coming off a decade of strong earnings and historically low borrowing costs
• Corporate bond yields have increased dramatically as prices dropped; the same bonds traded at premiums six
  months ago now trade at discounts to par. Creating potentially excellent buying opportunities.

Source: JP Morgan Asset Management

• Emerging market stocks have an inverse relationship with the US dollar; the chart below shows EM stocks (white) vs. USD (orange) over the past year. As rate hikes slow, we expect the US dollar strength to peak, potentially setting up a breakout rebound in emerging markets.
• Emerging markets are historically cheap based on valuation levels, leading us to prefer owning emerging markets over developed international for the next 6 12months.

Source: JP Morgan Asset Management

• Value stocks are finally in the winner’s circle relative to growth stocks. The chart below shows returns of Size (Large, Mid, Small) and Style (Growth, Value) over various time frames.
• This trend will likely continue through 2023 as we face recessionary pressures. Companies with strong balance sheets should continue to weather volatility better and pay dividends to equity holders.

Source: JP Morgan Asset Management

Market swings have become more violent in the past three years as we’ve seen outsized returns and outsized declines (for many reasons), but ultimately, we end up right back on the long-run averages. Despite the recent declines, the S&P500 has annualized +9.4% over the past three years (as of 10/19). Compared to +8.8% over the previous 20 years, 8.7% the previous 30 years, and approximately +10% over the last century.* Short-term volatility is an unfortunate hurdle to generating long-term returns because remaining calm and invested through turbulence can be challenging. The economy and the market run through cycles; this is nothing new. The target is consistently moving when trying to time markets, so staying the course and making small tactical changes each year is key to reaping the benefits of long-term compounding.

Below is a chart that shows the benefits of remaining invested over long time horizons and just how costly trying to time the market can be.