Quarterly Update

Updates like this one for the third quarter of 2022 (Q3) aren’t much fun to write. Instead of double-digit gains seen in recent years, losses across asset classes continued during the quarter in what’s become a gut check for long-term investors. The principal catalysts for these market conditions have been the same all year and Q3 was no different: global inflation and central bank response elevating recession risk here and abroad that increased uncertainty and market volatility.

Here’s a roundup of how major markets performed during Q3 and year-to-date, respectively:

  • US Large Cap Stocks: down 4.9%, down 23.9%
  • US Small Cap Stocks: down 2.2%, down 25.1%
  • US Core Bonds: down 4.8%, down 14.6%
  • Developed Foreign Markets: down 9.3%, down 26.8%
  • Emerging Markets: down 11.4%, down 26.9%

Global stock markets staged a bit of a comeback during Q3 until about mid-August before selling pressures mounted again. In the US, the S&P 500 (considered the simplest measure of the stock market) ended the quarter down nearly 5% and all of its sectors were down except for Energy which was up about 2%. The Communications Services sector that contains companies like Meta (Facebook), Alphabet (Google), Netflix, and Disney, continued its downward slide to about a 38% loss through quarter’s end. Even the Utilities sector, which typically holds up well during turbulent times is down 7% this year after a rough Q3. Foreign markets took a further beating with concerns about emerging economies like China. And, right at quarter’s end, fears about potentially ineffective fiscal policy in the UK impacted developed foreign markets and bled over to ours as well.

Probably the biggest issue on any given day during the quarter was the Federal Reserve’s response to inflation that continues to run hot, a little over 8% annually through September. In response to this decades-high inflation, the Fed raised rates twice during Q3 for a total of five increases this year, bringing the short-term benchmark rate it controls to 3.25% from near zero as the year began. Along the way members of the Fed continually reiterated that of their two jobs, trying for full employment and controlling inflation, the latter is the most important by far. Numerous Fed members told markets that, essentially, the Fed would bring down inflation even if a recession or other collateral damage to the economy resulted. Rapid rate increases and rhetoric like this should help slow inflation eventually but also creates a variety of knock-on effects, for which the timing and severity are unknown.

This continues to create a lot of uncertainty. For investors this means, among other things, that it’s hard to predict how much companies can grow in the near-term and what a fair price is for a company’s stock today. Some analysts think that corporate earnings will continue to grow into 2023, while others suggest that outlook is too rosy. Views on this have been shifting back and forth daily. In response, many short-term investors sell and as often happens, selling begats selling that is often indiscriminate in today’s market environment. So far this year we’ve had almost as many all-or-nothing days in the stock market as during the Covid market crisis of 2020, culminating in a drawdown of stock and bond values measured in the trillions.

That sort of selling continued in the bond market during Q3 as well, with the yield on the 10yr Treasury, a key benchmark, rising to nearly 4%, (bond yields rise as prices fall) from 1.5% in January. These numbers may seem small, but they have big impacts on bond prices and the world of finance more broadly. Examples of this were rising bond yields pushing the average 30yr mortgage rate to almost 7% during Q3, up from 3.3% in January, and the Prime Rate (on which credit card and home equity line interest is often based) to 6.25% from 3.25% a year prior.

Prices on high quality medium-term bonds fell another 4.8% during Q3 and are down nearly 15% this year. On one hand that sort of price decline presents opportunities to put cash to work at higher yields while on the other hand it hammers savers who already hold bonds. Fortunately, these bonds still pay interest and will return principal at maturity even though resale values have taken a hit in the meantime. Longer-term bonds, such as 20+yr Treasury bonds, were down over 10% during Q3 and nearly 30% this year. That’s as bad as the tech-heavy NASDAQ stock index. Typical investors don’t own a lot of long-dated bonds but declines like this are still incredibly unusual.

Stocks have been known to stage so-called relief rallies when prices fall too far too fast. The same thing is true for bonds. As I write the stock market is doing just that and the yield on the 10yr Treasury has fallen back to about 3.6%. Relief rally or not, we would welcome a rally by any name at this point in a year where there’s been nowhere for investors to hide. The last few months of the year have historically been good for investors… fingers crossed.

Like I said, market declines aren’t much fun to write about or to live through but live through them we must if we’re to build long-term wealth, generate cashflow during retirement and, ideally, leave something behind. This too shall pass, as they say, but the current environment is an opportunity to double down on our commitment to being long-term investors. It’s not for everybody and it doesn’t have to be, but short of starting your own business or becoming a real estate tycoon, investing in stocks and bonds is the best way to build your savings over time.

Have questions? Ask me. I can help. 

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