“The beatings will continue until morale improves.”

                           --- author unknown

The Federal Reserve made clear in recent weeks that aggressive rate hikes will continue until inflation improves. Wall Street took the news like the prospect for continued floggings. An encouraging summer rally quickly fizzled, as stock prices slipped back into bear market territory and closed out the quarter at fresh lows for a difficult year. As we search the clouds for silver linings, it now appears a lot of bad news is already priced into stocks, and we believe the upcoming quarter will reveal the tapering of monetary policy is within sight. While premature, the summer rally did show that markets react positively to indications that interest rates are stabilizing.  

More than any other factor, tighter monetary policy has made this a painful year for investors. The Fed has raised interest rates five times for a total of three full percentage points. Mortgage rates have more than doubled, bringing a sudden chill to housing markets. In their most recent commentary, the Fed signaled that we should expect another 75 basis point rate hike in November, a 50 basis point hike in December and perhaps a 25 basis point hike early in the new year, with a goal of bringing short-term rates into the 4.50 percent range. Fed Chairman Jerome Powell is fully prepared to see this policy through a recession in the hopes that our economy emerges with a more stable price environment. While the National Bureau of Economic Research (NBER) has not yet declared this officially, the recent two quarters of decline suggest our economy is already in a recession.

Inflation is an obstinate adversary once it has gained the upper hand. The August report for the Consumer Price Index (CPI) indicates inflation is still running hot at 8.3 percent. In a normal environment, we expect that figure to be around two percent. Consumer spending has remained high, although it may be due to people having to pay more for essentials. Prices are surging for rent, utilities, transportation and healthcare. According to the Labor Department, the cost of groceries jumped 13.5 percent over the recent year. Natural gas is an essential ingredient for nitrogen fertilizers, and much of the increase in food prices can be attributed to natural gas prices surging by more than 81 percent. Savings rates have suffered as consumers dip into savings to put food on the table.

Companies are contending with rising costs, worker shortages and ongoing trouble sourcing materials. Profits for the companies that comprise the S&P 500 are now expected to grow by a modest 3.2 percent for the year, a dramatic downward adjustment from forecasts of 9.8 percent growth at the end of last quarter. We anticipate some additional fine-tuning to those figures as analysts review earnings reports in coming weeks. Typically, the fourth quarter is when companies provide longer-term guidance for such items as hiring, capital expenditures and anticipated revenues.

As with all economic slowdowns, economists are keeping an eye on employment. Our ability to recover quickly from a recession will be stronger if people can easily find work. Headline figures for unemployment, new job postings and job growth have remained encouraging. The official unemployment rate is a mere 3.7 percent, and there are 11 million job openings for only six million people who are technically unemployed. However, that is not the entire story. The rate of participation in the workforce for our eligible population of people aged 16 to 64 years has not fully recovered to pre-pandemic levels. As a result, there are roughly three million fewer people in the labor force than historical guidelines would suggest. Economic output is defined by the number of workers multiplied by their productivity. Productivity is also slipping. According to the U.S. Bureau of Labor Statistics, recent figures for productivity reveal the largest decline since the data collection began in 1948. The pandemic changed the nature of work, people’s attitudes towards employment and expectations for work/life balance. The evolution of our workforce will have a profound impact on the rate of growth in the U.S. economy in the years ahead.

We continue to monitor three primary factors – the Fed’s battle with inflation, corporate profits and employment. The Fed appears to be nearing a point when they will taper their rate hikes, and the economy has already responded by slowing. Expectations for corporate profits now better reflect the difficult operating environment, and stock valuations are at historically attractive levels. Employment remains positive, for the most part, as there are plenty of open positions for people who are seeking work. Productivity and workforce participation rates have room to improve, although it remains to be seen whether those metrics will return to pre-pandemic levels.

Investors have endured a tough three quarters, which can test anyone’s patience. It is understandable if it feels like the beatings just keep coming. However, it appears we are finally reaching a moment when the Fed plans to relax their program of tightening monetary policy, and that could give the capital markets a welcome lift. Also, now that we are able to find good quality bonds yielding more than four percent, we plan to slightly extend the maturities as our latest round of Treasury Bills mature. Our program of utilizing 3-month Treasuries has been a productive strategy that helped preserve value while the Fed has been raising interest rates this year.

Please enjoy wonderful Fall and Winter holidays with family and friends, and feel free to contact us at any time if you have questions or concerns you would like to discuss.