Fireworks End with a Bang
Last week people across our great nation watched fireworks shows to commemorate our country’s independence. Most displays end with a grand finale consisting of many fireworks going off at once, resulting in a big BANG! We experienced plenty of fireworks in the markets during the first half of the year, but is the show over or is the big bang yet to come?
There were many underlying themes during the first half of 2022 including stretched stock valuations, especially in tech stocks; war in Ukraine; high energy prices; the highest levels of inflation seen in 40 years; interest rates moving higher; and a slowing economy with the possibility of a lingering recession. Most of these are somewhat inter-related but the combination of all led to the worst first half of the year for the S&P 500 Index since 1970. The Bloomberg Barclay’s Bond Aggregate suffered its worst losses on record. Almost all major asset classes had negative returns, with most being lower by double digits. The only bright spot was commodities, which were broadly higher by about 30% year-to-date despite giving up nearly 10% in the month of June. To say 2022 has been difficult for the markets and investors might be a bit of an understatement.
With the stock market dipping into (and out of) bear market territory and the threat of a recession looming, it may seem the carnage may not be over. Many market “experts” have said the markets we will not reach a bottom until we reach a point of widespread capitulation, where investors sell, basically giving up and losing hope of recouping the lost gains. When this happens, it can be very dramatic with a large, very rapid downward swing in the markets; similar to a big bang at the end of a fireworks show. Do we need to experience capitulation before the markets move higher? We would argue the answer is no. Instead of a big bang, the markets might quietly start to ascend. For those that did sell when the market was lower and are waiting for a major drop, they could miss out on the rebound.
What will the second half of the year bring? Stock markets making a move higher in the first week of July give reason for optimism. There are signs the market may be oversold. Economic growth does appear to be slowing but there are indications that things are not as bad as they may seem or are being reported. Consumer spending, while slowing, seems to remain mostly intact. Anecdotally, TSA reported airline traffic is exceeding pre-pandemic levels showing there is still an appetite for travel despite higher ticket prices from increased demand and higher fuel prices. The June employment report, which was released Friday, exceeded expectations reflecting a still robust labor market and continuing levels of low employment. A recent CNBC survey of strategists from 16 major Wall Street investment banks showed that all expected the stock market to be higher by the end of the year, compared to where it is now. History does not always repeat itself but it is worth noting that the last time the market was down this much, in 1970, the S&P 500 returned 26.5% in the second half of the year.
Inflation continues to be a major theme in the markets, coupled with possible Federal Reserve action. Current expectations are for the Fed to raise short-term interest rates by another 75 basis points, or 0.75%, during their next meeting at the end of this month. Looking out further, rate hikes of 50 basis points (0.50%) at both the September and December meetings are now anticipated bringing the Federal Funds rate to 3.50% by the end of the year. We do not have the same optimism for bonds as we do for stocks since higher interest rates cause bond prices to drop. Somewhat surprisingly, there is a growing probability being priced into the market that the Fed will lower interest rates sometime in 2023 to combat slower growth. If that does occur, the Fed may be able to declare victory in their inflation fight even if it comes at the expense of pushing the economy into a recession. Much can happen in coming months, so we are reluctant to put a great deal of confidence into such a scenario taking place.
As we have mentioned numerous times, whether or not we enter a recession might be a moot point for the stock market since a recession may already be priced in. We will find out later this month if second quarter GDP was negative, which would put us into a “technical” recession with two consecutive quarters of negative growth. If that is the case, GDP growth is only slight negative so while it meets the definition of a recession it would be very shallow in comparison to past recessions.
This coming week will bring key inflation reports, Consumer Price Index (CPI) and Producer Price Index (PPI), both of which are expected to remain elevated. We are going to go out on a limb here and predict that the CPI comes in a little lower than expectations since energy prices and housing costs pulled back a bit during June. It will not be a dramatic change from what we have seen the past few months but might be enough to give some hope that inflation has peaked. Even if this is the case, we expect inflation to remain elevated for at least the next several months. Unless the CPI report largely surprises to the upside, it is doubtful it will impact expected Federal Reserve action at the end of the month.
One thing is for certain, even if we are bouncing off the lows and on an upward trajectory there will again be times in the future where we have substantial market pullbacks and we experience bear markets. Be prepared for these by ensuring you have a solid, unflappable income plan in place to maintain your lifestyle and your investments are properly allocated for your level of risk tolerance. Make sure your retirement plan can outlast any fireworks in the markets.
Have a wonderful week!
Nathan Zeller, CFA, CFP®
Chief Investment Strategist
Please contact us if you would like to review your individual financial plan or learn how the TaxSmart™ Retirement Program can help you.
Office phone # 952-460-3260