September 2022
Market Update

Mt Nebo (11,929 ft) is the highest peak in Utah County along the Wasatch Mountains.  This is a popular hike, so the trail is well maintained and easy to follow.  Around 9,000 ft a bench trail runs level North to South, as it reaches Wolf Pass at an elevation of 10,643 ft.  From there, you look up to a peak and the trail begins to rise sharply.  This becomes the most strenuous part of your journey, and you begin to climb a 30-40% grade and in ½ mile you’ve just gained ~800 ft in vert.

As you crest the top, your legs are exhausted, you’re breathing heavier and to make matters worse, you realize, it’s a false summit! 

A false summit, in mountaineering speak, is a point on a trail that fools you into thinking you’ve made it when you still have a lot more ground to cover.  This is typically caused when the ridge or features of the mountain in front of you limit your line of sight.  This can be very disheartening — especially if you’ve already been hiking for hours!

From here, it’s not a bad idea to take a short break, get your legs under you and then begin the last leg of the journey scrambling along the rugged ridge and then up to your end goal.  The views of the valley are breathtaking!

So why am I sharing this story?

The markets can often feel like an extended backpacking trip with several false summits along the way. Since the lows in mid-June, the market had advanced roughly 17% before rolling back over.  This strong recovery had many asking, is this recent rally in the market the beginning of a new bull market or just a bear market rally?  A bear market rally has a similar feeling of when you reach a false summit.  Just when you think you have made it through the worst, the market starts trending back down again.  Time will tell if we’ll hit some new lows or advance higher with a sustainable rally.  Either way, now is a good time to build up your emotional reserves, plan for some false summits and keep your eyes trained on a longer horizon.

Market Performance

After a strong July, the major asset classes declined in August.

4 Major Headlines

 1)     Bear Market Rally or Start of a New Bull?

 The market, as measured by the S&P 500, declined over 23% from its high and entered bear market territory, but by mid-June we started to see that trend reverse.  Have we ever seen a rally greater than 17% with a bear market not being over?  In the last 25 years, we have seen this happen several times.  In 2000-2002 and in 2007-2008, we saw the S&P 500 rally between 18-24% five separate times and then go on to hit lower lows in the months and years ahead.  However, in 1998, 2011, 2018 and 2020 the market dropped at least 20% and then rallied and never looked back.  It’s entirely possible this is a rally off a sustainable bottom, and stocks will move to new highs; however, history does not imply that outcome is likely, and so far, this rally falls well into the category of a “bear market rally” according to history. 

Figure 1

2)     Why Has This Rally Occurred?

Comparing market moves to history is a helpful guide, but to better understand whether this is a bear market rally or the start of a bottoming process, we must understand WHY the rally occurred from mid-June to mid-August.

We would point to four main ideas:

• Fed Tightening Expectations

  • Likely the primary reason for the strength of the rally comes in the hope that if inflation is peaking, the Fed will slow down their interest rate hikes.  In fact, the market seemed to be pricing in the lowering of rates next year and that was dispelled by numerous Fed officials and directly by Fed Chairman Powell in his Jackson Hole speech last Friday.  Given that we have only had one inflation report showing signs of decline, the Fed will require a sustained downward trend of inflation before they start to change course.

• Extremely Negative Sentiment

  • Following the stronger than expected inflation (CPI) report, markets collapsed, and sentiment became historically negative.  We must go back to 2008-2009 to see readings this low!  These extreme levels are usually found near market lows and often is considered a contrarian indicator.  For now, some of that negativity appears to have worked itself off, but it remains negative. 

Figure 2

• Better than expected earnings

  • The Q2 earnings season was better than feared.  Not only have the vast majority of companies beat estimates, but most importantly the expected 2023 earnings didn’t materially decline.

• Signs inflation may have peaked

  • This rally gained steam when several commodity prices began to drop and manufacturing surveys and indices declined, which led many investors to start pricing in peak inflation, and then the July inflation (CPI) report confirmed those expectations.  The August inflation report will be released on September 13th and the hope is that we continue to see signs of inflation trending downward.

In order for this rally to be sustainable, we would like to see earnings remain strong and continued improvement on inflation, which should allow the Fed to ease their tightening process. 

3)     Fed Balance Sheet Reduction Ramping Up

One of the biggest unknowns for the market is the impact of the whopping 95 billion per month reduction in the Fed’s balance sheet that is scheduled to start this month.  We are in uncharted territory at a level none of us (including the Fed) has ever seen before.  Some have argued that balance sheet reduction may have just as much or more impact than rising rates.  At this point, we believe this will continue to be a headwind on the markets and even though it may mean some additional pain in the short run, getting inflation under control and having the Fed’s balance sheet reduced in the long run will be better for our economy.

4)     The Price of Admission

During volatile times, the day-to-day or month-to-month fluctuations can drive investors to make some very emotional decisions and often we have found that emotion is the enemy to good investing.  These are the monthly returns in the S&P 500 so far this year:

• January -5.2%

• February -3.0%

• March +3.7%

• April -8.7%

• May +0.2%

• June -8.3%

• July +9.2%

• August -4.08%

There have been 3 months already this year when the market fell 5% or more.  That didn’t happen once last year, and it only happened twice in 2020 and didn’t happen in 2017, 2016, 2014 or 2013.  In fact, down 5% in one month doesn’t happen very often but they’re not completely out of the ordinary as they historically happen about once a year.

The last time we had this much month-to-month volatility was 2008, when the market fell more than 5% in 5 different months.   On the flip side, volatility tends to cluster during downtrends so some of the strongest monthly returns happen around the weakest months.

The price of admission to the stock market is dealing with volatility that will inevitably bring up those painful emotions when you witness a chunk of your life savings evaporate before your eyes.  The trade-off for dealing with that emotional roller coaster is long-term returns above the rate of inflation and experiencing the compounding effect of one of the greatest wealth-building machines ever created.

You don’t get this:

…without experiencing this:

That is the nature of the markets.   

In your portfolios here during the month of August, we have shifted back mostly to cash within our bond strategy as interest rates resumed their upward trend and volatility returned.  On the stock side, we have also reduced our exposure and we continue to maintain our defensive stance.  As always, if you are feeling uneasy about the market volatility, please reach out to us and we can revisit your situation.

Lastly, as we enter the last 4 months of the year, we’ll begin our year-end planning discussions and hope to continue to find creative ways for you to be more tax efficient with your investments, required distributions and charitable donations.  The holidays will be here before you know it.

We hope everyone had a fun and safe Labor Day weekend. 

If you have questions, please contact us.

FINANCIAL PLANNING
TAX PLANNING
401(K) ALLOCATION

To download the September 2022 Newsletter: CLICK HERE