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Federal Reserve Sparks Investor Fears Thumbnail

Federal Reserve Sparks Investor Fears

Both the stock and bond markets took a big move down last week dropping the major indices back to their lowest levels of 2022.   This latest move was the result of persistently high inflation and the Federal Reserve’s bark and bite which has increased the probability that a recession is on the horizon.  

Traditional recessions are uncomfortable for everyone, and they are devastating for those directly affected by job loss or business closures but for long-term investors they tend to give way to some of the best market returns.  Markets will stabilize before the real economy feels good and before the confirming data comes in.  The challenge to long-term investors is to remain resilient, confident, and patient so that you are in the game when the market tide turns.

This has been a historically challenging year for investors; almost all asset classes have lost money year to date.  We recently concluded a deep dive on our client portfolio allocations and holdings; we remain convicted to both.  

Federal Reserve is focused on reducing inflation at any cost

Last Wednesday the Federal Reserve announced its third consecutive .75% rate hike.  The hike to the federal funds rate was largely expected by markets, however it was chairman Jay Powell’s comments during the press conference that markets reacted the most to.  In those comments, the Chairman announced that he expected the Fed to raise rates by about another 1.5% between now and the end of the year, a much faster pace to than the market had been pricing in.   He also put the world on notice that to bring inflation down it is becoming increasingly likely that we will need to drive the economy into a recession.   

Recessions have typically given way to some of the best periods of market returns

The good news about recessions is that they typically haven’t lasted very long.  Looking back at the 11 cycles since 1950, recessions have persisted between two and 18 months, with the average spanning about 10 months.1  For investors, the reward for enduring the discomfort of a recession are in the returns experienced coming out of the recession.   As you can see from the chart below some of the best periods of market returns have come in the 1-year period following a recession.  

Nowhere to hide

Side stepping, the pullback in markets this year was all but impossible as nearly every asset class has suffered negative returns year-to-date (see below).  The good news is that in prior periods where this has occurred, we see a quick reversal to more normal correlations and where diversification benefits are restored.  

Looking ahead

If we conclude that we are currently or will soon be in a recession, then we can also conclude that we are that much closer to being through it and experiencing the investment benefits on the other side.

The fixed income markets are starting to look particularly health.  Rising rates have pushed the bond yields up allowing investors to earn a meaningful return from their bond allocations for a change.   As of 9/26, short-term treasury rates are over 4%.    To this point rising bond yields have hurt bond prices but that trend could reverse itself if a recession descends on the economy and there is a flock to safety.

For stocks, to this point we believe that the sell-off has been rather orderly and a natural adjustment to higher inflation and higher interest rates.  In the weeks and months ahead, we could be entering the “fear” part of the market cycle where we see some indiscriminate selling of stocks that can result in certain segments becoming oversold and attractive places for tactical positioning.   

The confounding thing for most investors is that it’s a fool’s game to time when exactly the market losses will bottom, and the rebound will take hold.   Historically, market rebounds are swift, and they start before the economy is out of a recession.  

Next week we will be putting out our Q3 market commentary where we will go into more details on the weeks and months ahead.  To make sure you get the commentary please follow @FortyWealth on Twitter, LinkedIn, Facebook.

1Capital Group: Guide to Recessions, 9/19/2022