In the last several weeks, we have continued to face elevated uncertainty in financial markets due to high inflation and rising interest rates. We believe it is an important time to take stock with the final quarter of 2022 just days ahead.
It has been a difficult year, not only for investors but also for households and businesses as we navigate higher prices along with higher cost of borrowing to finance short term needs or operations for businesses. Economically speaking, there remains challenges ahead as the Federal Reserve (Fed) continues to raise rates in their attempt to control inflation. We believe the Fed is doing the right thing for the long-term health of the economy, while also increasing the near-term economic risks. As the efforts of the Fed continues and we see how sticky inflation can be on the economy, I am reminded that inflation is the one guest at the dinner party that never leaves.
Given the risks, we are receiving many questions about stagflation and concerns that we may again be facing the investment environment of the 1970s. This is not your 1970s- style stagflation. While growth has stalled and inflation has been high, the unemployment rate has remained very low. The average unemployment rate during the stagflationary years in the 1970s and early 1980s was 6.7%, compared with just 3.7% in August of this year. Unemployment will move higher, but it’s likely to remain low by comparison, giving the economy is more resilient than in the 1970s.
At the same time, inflation is decelerating. For example, Gas prices and agricultural commodity prices, have declined throughout this summer. Moreover, rents in some areas of the country are dropping, durable goods prices are declining, and many import prices are falling. When our central bankers are sufficiently convinced, the Fed can slow the pace of tightening as inflation moves closer to their long-run target. Some of the recent market volatility has come from mixed inflation data and signals, so as these data points become more aligned, we expect volatility will fall and investor sentiment will improve.
The level of bearishness right now is very high, but remember that historically extreme negative sentiment has often been followed by strong market performance. The American Association of Individual Investors (AAII) has been doing a weekly survey since the 1987. Last week’s survey had a level of bearishness seen only four other times before. Subsequently, the S&P 500 returns a year later averaged over 30%. We don’t know whether that will happen again, but just like in 2020, when a lot of negative sentiment is being priced into markets, it may set the bar low for stocks to outperform expectations.
Investors should avoid the impulse to time the market, and should spend time in the market focused on their allocations, rebalancing, and repositioning for current investing landscape. Bank of America did a study on S&P500 returns over the decades. Specifically in the decade starting in 2010, the price return on the index was 190%. But if you missed only the best 10 days of the decade, your return was slashed to 95%. From 2000-2010, the price return on the S&P was a negative 24%, but if you missed the best 10 days, your return was actually a negative 62%. And since the start of the current decade, it’s been no different and even more lopsided due to the increased volatility experienced from Covid-19 and the bear market of 2022.
We also have some positive seasonal patterns ahead with November through April being historically strong months for equities along with positive historical stock performance after mid-term elections and the third year of the four-year presidential cycle has historically been the strongest for the equity markets.
Never the less, the recent declines are concerning and we can’t be certain when the volatility will end. We do know that conditions continue to indicate that better times are ahead. Market volatility and negative sentiment can make it harder to make investing decisions, but we believe the surest path forward remains sound financial advice centered around a comprehensive financial plan.
When it’s most painful to do so, it’s most critical to stay safe, and stay the course.
Please contact me if you have any questions.
Scott A. Shaw, CFA®, CFP®
CIO | Chief Investment Officer
40 E Montgomery Ave, 4th Floor Ardmore, PA 19003
Office Phone: 215-982-2743
Fax Number: 215-827-5814
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