Strategy and Positioning written by Steve Orr, Chief Investment Officer; and Essential Economics written by Mark Frears, Investment Advisor

As of market close September 23, 2022. Returns in percent.

 Strategy & Positioning 

 — Steve Orr 

Three Legs

Last week was another Bear week to forget. Bond prices fell between 1.5% and 2.5%. Stock indices fell anywhere from 3% to 5%. The tech heavy NASDAQ fell 5% and some of the very bigs — think Apple, Nvidia and Google — broke below their June lows for the first time. 

To date this Bear Cycle for stocks has been fairly typical. Non-recession Bears typically last about 200 days and fall 23%. This cycle is 178 days in through last Friday and the drop from all-time highs is about 24%. This is the sixth Bear cycle that has had three separate legs of 10% or more drops. There is no consistent pattern to any of the prior cases, or guidance as to how much lower this Bear cycle will go. 

Stock and bond prices fall when traders are not sure how far or how fast the Central Bank will go in shutting off the monetary spigots. We have enjoyed 12 years of easy money policies and ultra-low interest rates from Central Banks. It was an abnormal period in markets, and it took pandemic shutdowns with a gusher of monetary support to bring it to an end. 

Last week the Fed continued its inflation war campaign by raising its Fed Funds target another three quarters of a percent to 3.25%. With core inflation running between 5% and 7% depending on the inflation index, the Fed has a way to go. Remember, each rate increase takes between nine and 12 months to work its way through the economy. So, the first increase back in March has yet to be fully felt throughout the economy. This is one reason why recession fears in early 2023 are rising. The concern is that the Fed will not know how much damage it is doing until it is too late.  Housing is already taking the brunt of higher rates. 

W-I-F-E

We have been using the initials W, I, F, E to follow the Macro pressures on our portfolios. The war news is slightly better, but we still do not have a good idea of fertilizer and crop impacts going forward. Putin is saber-rattling about nuclear options and looking for recruits. We heard one report late last week that the last open border gate with Finland had a queue over 30 kilometers long of Russians trying to leave their country. 

Inflation may have already peaked, but producer and input prices staying elevated will continue to push recession risks higher, especially in Europe. Energy is key for manufacturing and home heating in the winter. Consider that Texas natural gas for delivery next month is $6.80 mm BTU. The same gas at the Netherlands hub goes for $51, a mere 7x higher. Which explains why the German government took over their largest private utility last week.

As for the Fed, Chairman Powell says he will “keep at it” (his words) until he breaks it — we hope he means inflation, not the economy. FOMC members expect the funds rate will finish this year around 4.4% and end 2023 near 4.6%. They also believe they will be successful in raising unemployment a full percent to 4.4%. That implies at least 1.5 million jobs lost. Be prepared for more layoff news. Fed Funds futures this morning are pricing rate increases for November’s meeting at three-quarters of a percent and another one-half percent at the December 14th meeting.   

Remember the Fed is fighting not only Wall Street, but also Congress. The “Inflation Reduction Act” continues Congress' free-spending ways. Expect more spending to be shoved into this week’s continuing resolution to keep government open into December. Cue the “Government Shutdown” headlines in the coming days. 

War, Inflation, Fed and other central banks combined are a unique mix that, to date — and we mean just right now — is causing a mild slowdown here in the US, and the beginnings of a recession in Europe and parts of Asia. There are a few signals flashing tough times ahead. OECD Composite Leading indicators down 13 of the last 14 months, are now down to 2008 -09 levels. Investor sentiment is also falling to 2008-09 levels. It usually bottoms out about five months before recessions ends but has not stopped falling yet. All the above are resetting earnings estimates lower for stocks. Once earnings estimates are lowered then prices should follow. 

There will be plenty of news points over the next several weeks that will keep pressure on all markets. The first two weeks of October bring September job and then inflation reports. Mid-October starts third-quarter earnings season. Bellwether FedEx dimmed investor hopes after a dire outlook last week. Once earnings season is well underway, traders get another Fed meeting on November 2nd, and then mid-term elections.