Persistent inflation, fueled by energy market disruptions, has wreaked havoc on global investment markets in 2022. Fighting inflation is now the number one priority for the US Federal Reserve Bank (“the Fed”) and the Fed continued to aggressively raise interest rates in the 3rd quarter. Higher interest rates have caused a slowdown in US economic growth and threaten to push our economy into a recession. Nearly all sectors of the stock market ended September in bear market territory and most sectors of the bond market are down more than 10% for the first nine months of 2022.
How did we get here and where do we go next? After more than a decade of inflation near 2%, the cost of living began drifting upward in the spring of 2021. The $1.9 trillion American Rescue Plan was passed in March 2021 when the US economy was already rebounding strongly from the COVID-19 pandemic. This additional stimulus boosted consumer demand in an economy that was experiencing product shortages due to supply chain issues. By year-end 2021, the annual consumer inflation rate reached 7% and it became clear that inflation was not transitory.
The Fed reacted slowly to rising prices, finally shifting its low interest rate and Quantitative Easing policies in March of 2022. The US economy had already started to slow, but with a strong employment market, the Fed decided to focus on reducing inflation, which had surged to a forty-year high. With COVID-related stimulus funds drying up and borrowing costs rising, both fiscal and monetary policies are now headwinds for the US economy. If the US economy is not already in a recession (GDP growth was negative in both the first and second quarters of 2022), current conditions make it hard to argue that a recession is avoidable.
Higher interest rates are starting to dampen one of the bright spots for the 2022 economy: the housing market. While investment markets have plummeted, the value of our houses has soared to all-time highs. Home buying demand remains high, but high prices and mortgage rates above 6% are stifling many buyers, especially first-time home buyers. A weakening housing market could help push the economy into recession.
The other bright spot for the US economy in 2022 has been the labor market. The headlines are impressive: 3.7% unemployment rate, a monthly average of 450,000 jobs created and over 10 million jobs available.
Even though businesses have hired about 3,600,000 net new workers in 2022, US economic output has declined. We are experiencing the return of stagflation, with stagnant economic growth and rising inflation. The job market appears strong now, but stagflation threatens the momentum built up during the recovery from the pandemic.
Despite all the worries about inflation and recession, investment markets could still be poised for a rebound. Bond prices are now trading at steep discounts to their par value. Bond defaults remain low and most of the bonds will mature at par, which could mean solid gains for bond owners over the next few years if interest rates are stable or decline.
Price/earnings ratios for stocks are below their long-term averages based on projected earnings for the coming year. These more attractive valuations in the current stock and bond markets have historically led to solid long-term investment opportunities.
While the Fed’s interest rate decisions and corporate earnings are key drivers of investment market results, government policies and geopolitical conflicts also have an impact. In the US, the mid-term election in November will likely move the market. Investment markets have performed better on average when government power is split compared to when one-party controls both the executive and legislative branches. Outside the US, economic conditions have weakened even more than in the US. The end of the war in Ukraine could provide a spark to reignite global economic growth. However, these political changes are uncertain at this point but could benefit investment markets over the next 12 months.
This article was authored by Christopher Borden, a financial advisor and Managing Partner located at Canby Financial Advisors, 161 Worcester Road, Framingham, MA 01701. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. He can be reached at 508.598.1082 or email@example.com
Disclosure: Certain sections of this commentary contain forward-looking statements based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets. Investments are subject to risk, including the loss of principal. Because investment return and principal value fluctuate, shares may be worth more or less than their original value. Some investments are not suitable for all investors, and there is no guarantee that any investing goal will be met. This material is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Talk to your financial advisor before making any investing decisions.
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