Most major equity markets declined in August. The S&P 500 declined by 4.0%. The Nasdaq 100 index of technology-oriented companies dropped 5.1%. Bonds declined in price and rose in yield. High and persistent energy prices in Europe coupled with persistent strength of the US dollar remain headwinds for US investor in international equities.
Global equities as measured by the MSCI ACWI (All country world index) lost 3.6%. The Bloomberg Barclays US Aggregate bond index declined by 2.8%. 2022 has been a challenging year for a 60% equity / 40% fixed income portfolio with both losing value year-to-date.
August reminded us that following one’s emotions is a great way to lose money in the equity markets.
In June, markets were down on fears about stagflation (slow to no growth with high inflation). During July, the markets shot higher on lower inflation numbers, stronger corporate earnings and hopes for softer Fed interest rate policy. In August, the markets reversed course lower over fears that a good economy is bad for future inflation and hence continued, restrictive Federal Reserve monetary policy.
Bottom line – reacting to the markets is a fool errand. Have a plan and stick with a disciplined approach.
Here is what we are looking at going into the Fall:
- Inflation has likely peaked but may remain stickier for longer (more persistent high prices). We will next learn about the direction of inflation on September 13th.
- The Federal Reserve will continue to be active. The Fed is expected to raise the federal funds rate by 0.50% or 0.75% in their meeting on September 21st. The Fed will also step-up efforts this month to reduce its balance sheet (quantitative tightening) by selling $60 billion of Treasuries and $35 billion mortgage-backed securities. This some-what wonky Fed maneuver reduces reserves that banks depend on when making loans.
- Long-term interest rates have headed back higher. Interest rates rose in the US in August. The 10-year yield rose to 3.1% and the 30-year yield increased to 3.3%. Rising rates cause mortgage financing rates to remain high, negatively impacting housing affordability. Recently, the average national 30-year fixed mortgage was 5.6% up from 3.1% at the end of 2021.
- Will US economy remain strong? For now, good economic news is seemingly actually bad news for risk assets like stocks. More people employed translates into greater demands for goods and services, likely higher and stickier inflation and hence the likelihood of additional interest rates increases by the Federal Reserve. We will continue to monitor economic data.
- US Dollar/Russia/China lockdowns: The dollar strength has made it a tough year for non-US equity investments. Russia’s use of energy as an economic weapon has all but ensured Europe is heading into a recession. The US dollar is up 13% vs. the Euro and 24% vs. the Yen for the year. Emerging market currencies have been hit even harder. The US dollar has also appreciated by 9% vs. the Chinese Yuan. Additionally, the rolling COVID lockdowns in China, continues pressuring emerging market equity returns for US investors.