Our breakdown of the markets in the third quarter followed by a look ahead to fourth quarter.
Coming up, we look back at the 3rd quarter and then look ahead to see when we might see an end to the bear market.
From Thrivent Asset Management, welcome to episode 39 of Advisor’s Market360™. A podcast for you, the driven financial advisor.
The bad news: stock and bond prices have plunged. Housing sales have fallen. Mortgage rates are up. Job openings are starting to dwindle. And the manufacturing sector is showing some early signs of weakness.
The good news, for consumers at least, gasoline prices have dropped.
Will the 4th quarter be another good news/bad news quarter? Listen on – our outlook will provide answers.
But first: a review of the 3rd quarter. To help us break it down, we tapped into Thrivent Asset Management’s team of experts led by Steve Lowe, CFA, Chief Investment Strategist. We’ve got lots to cover, as usual – so fill your cup and cozy up as we turn our attention to the quarter that was.
As dire as our current situation may seem, it’s exactly what the Federal Reserve, or Fed, had in mind when it undertook its monetary tightening initiative. But the ultimate goal of the policy – curtailing rampant inflation – is still a work in progress.
Let’s talk about inflation: the Fed has indicated that it will continue to bring the pain in the form of ongoing rate hikes until inflation is under control. The Fed raised rates an additional 0.75% in September, pushing the total rate increase for 2022 to 3%.
While there are signs that inflation may be abating, there’s still plenty of room for improvement. According to the U.S. Department of Commerce, the annualized increase in the cost of goods and services has continued to hover at just above 6%. One indicator of inflation, personal consumption expenditures, or PCE, increased by 0.4% from the previous month in August. Personal income measures fared similarly. The PCE price index was up just 0.3% in August, but it was 6.2% higher than a year earlier – but excluding food and energy it was up 4.9%.
The Consumer Price Index, another inflation indicator, was up just 0.1% in August compared with the previous month, but it was up 8.3% compared with a year earlier, according to the U.S. Bureau of Labor Statistics.
Housing prices have already started to decline, according to the Federal Housing Finance Agency. In July, the U.S. house price index posted its first month-over-month decrease since May 2020, which was during the peak of the pandemic, with prices dropping 0.6%. Mortgage rates are more than twice as high as they were a year ago, according to Freddie Mac, moving from 2.87% in September of last year to 6.7% this September. With that, the decline in home prices is expected to accelerate in the months ahead.
For the job market: robust as it is, some signs of weakness appeared in August. Job openings declined from about 11.2 million in July to 10.1 million in August, according to an October 4th report from the U.S. Bureau of Labor Statistics.
Manufacturing activity continued to expand for the 28th consecutive month in September; the rate of growth was the lowest since May 2020, according to the Institute for Supply Management. The report also noted that new orders declined in September, while production edged up modestly.
That wraps up a wide-angle lens view of the trends – now let’s switch lenses and look at the numbers a little closer, starting with equities.
The S&P 500® Index – representing the average performance of a group of 500 large-cap stocks – has been impacted by Fed tightening policies, dropping almost 5.3% in the 3rd quarter. The total return of the S&P 500, including dividends, was down close to 4.9% for the quarter and down 9.2% in September. Year to date, the total return was a negative 23.87%.
The NASDAQ Index, the electronic stock exchange with more than 3,300 company listings, was down just over 4.1% in the 3rd quarter. Year to date, the NASDAQ is down 32.4%.
On the retail front: recovering from inflation concerns, sales were up 9.3% over the three-month period from June through August, as consumers continued to recover from the pandemic slow-down, according to the September 15th Department of Commerce retail sales report. Compared with the same period a year earlier, retail sales were up 8.1% in May.
Within retail, let’s zoom in to auto sales, building material sales and department store sales. These three segments were all up from the previous month and from a year earlier. The biggest increase from August was in Autos – up 3% – and from a year earlier, building materials saw the biggest increase – up 10.5%.
On the other hand, non-store retailers, primarily online, were down 0.7% for the month, but, compared to a year earlier, the segment was up 11.2%.
Finally, restaurants and bars continued to recover from the pandemic, with sales at food services and drinking establishments up 1.1% in September and 10.9% from a year earlier.
263,000 new jobs were added to the economy in September, according to the Employment Situation Report issued October 7 by the Department of Labor. It was the 21st consecutive month of job growth in the U.S.
The job growth came despite the Fed’s efforts to tighten the money supply and cool off the economy. The unemployment rate moved down slightly from 3.7% in August to 3.5% in September, returning to its July level.
Wages continued to rise, with average hourly earnings increasing from an average of $32.36 per hour in August to $32.46 in September. Over the past 12 months, wages were up 5%.
The slump in stocks was felt in all but two sectors of the S&P 500 in the 3rd quarter, with 9 out of 11 sectors in negative territory. Communications Services fared the worst, down almost 13% for the quarter. Real Estate also took a beating, down just over 11%.
The two sectors up for the quarter were Consumer Discretionary up nearly 4.4% and Energy, up 2.35%. But if we look at the first nine months of 2022, Energy is still up close to 35%.
And now, a lightening round of vital statistics from the 3rd quarter:
Bond yields continued to move up as the Fed raised rates. The yield on 10-year U.S. Treasuries rose 0.82%, from 2.98% at the end of June to 3.8% at the September close. So far this year, the Fed has hiked rates 3% in an effort to bring inflation under control, including a 0.75% rate hike in September.
Corporate earnings projections climbed before expectations took a step back in the 3rd quarter as the economy slowed. The 12-month advanced earnings per aggregate share projection for S&P 500 companies dipped 0.18% in the 3rd quarter but is still up 4.46% year to date.
The forward price-earnings ratio, or P/E, of the S&P 500 continued to trend down in the 3rd quarter, due to the stock market’s tumbling. It moved from 15.8 at the end of June to 15.15 at the September close. The P/E has dropped 6.18 from the 2021 closing level of 21.33.
The forward 12-month earnings yield for the S&P 500, the inverse of the P/E, edged up for the quarter, from 6.34% at the end of the 2nd quarter to 6.61% at the September close. The 12-month forward earnings yield can be helpful in comparing equity earnings yields with current bond yields. While bond yields have increased significantly this year, the earnings yield is still well above the 3.80% market rate of 10-year U.S. Treasuries.
The dollar is at a 20-year high relative to the world’s other major currencies. The Euro depreciated almost 6.3% versus the dollar in the 3rd quarter, with the war in Ukraine impacting the European economy. So far this year, the Euro has depreciated just over 8.5% versus the dollar.
The dollar was up just over 6.5% versus the Yen in the 3rd quarter and up 25.7% versus the Yen through the first nine months of 2022. The drop in the relative value of the Yen has been attributed to a loose monetary policy by the Bank of Japan versus an intensive tightening policy by the Fed.
Oil prices reached a high of well over $100 per barrel, but finally dropped in the 3rd quarter over rising concerns of a potential global economic slowdown. West Texas Intermediate, a grade of crude oil used as a benchmark in oil pricing, dropped just shy of 15.5% in the 3rd quarter, from $105.76 at the end of the 2nd quarter to $79.49 at the September close.
But OPEC Plus, a consortium of oil-producing nations, announced plans recently to cut oil production by two million barrels a day beginning in November, which could drive oil prices back up again.
Gas prices at the pump also declined significantly in the 3rd quarter, from a national average of $5.11 per gallon at the June close to $3.83 at the end of September – a decline of over 24% for the quarter. However, through the first nine months of 2022, gasoline was still up about 13.5% from its 2021 closing price of $3.38 per gallon.
Now for gold prices: despite high inflation, the price of gold moved lower in the 3rd quarter, dropping nearly 7.5%. Year to date, gold is down about 8.5% from its 2021 closing price.
International equities followed the lead of U.S. stocks in the 3rd quarter with the war in Ukraine continuing to be a drag on the European economy. The MSCI EAFE Index dropped 10%, and year to date, the index is down almost 29%. The MSCI EAFE Index tracks developed-economy stocks in Europe, Asia, and Australia.
That wraps up our review of the 3rd quarter. Top off your drink as we look ahead to the 4th quarter. Admittedly it doesn’t look great, but it is not un-bear-able.
What’s the market outlook for the 4th quarter of 2022? We asked Steve Lowe to weigh in and he delivered—he noted that after taking a short summer hiatus, the bear market roared back with intensity across all asset classes as the 3rd quarter came to a close. The question on everyone’s mind is: when will this bear market end?
To answer this fundamental question, it is important to first examine the factors that have continued to stoke this bear market, those being: high inflation, restrictive monetary policy, sharply higher interest rates, and the grinding war in Europe.
Markets will continue to be driven by these four basic realities for at least the next six months. So, what is the outlook for these key drivers?
To begin, it’s important to remember that these are interconnected – meaning one driver can affect others.
On the inflation front, it has declined modestly since the beginning of the year – but it remains unexpectedly high and persistent. There are multiple drivers of inflation, but the most important are the supply and demand dynamics in the economy that are manifested in commodity prices, consumer inflation expectations, wage demands and money supply.
Looking at commodity prices, they have declined materially since June, with a broad basket of commodities down 20%, and oil prices down 26% through the start of the 3rd quarter. Although commodity prices are a relatively small component in inflation statistics, they are an important indicator of underlying inflationary pressures. With global economies weakening, commodity prices seem poised to continue their descent from extremely high, pandemic-induced levels.
The war in Ukraine has also had a major impact on commodities, especially energy. The outlook for this tragic conflict remains uncertain, with both Russia and Ukraine expressing their resolve to prevail. This global uncertainty will continue to elevate the level of risk that financial markets must factor into asset valuation.
Let’s now turn to consumer inflation expectations, which are a key element of actual inflation. They have diminished in recent months. Although this is a rather soft indicator, it’s encouraging that it’s showing moderation in the minds of consumers.
And even though the expectations have dropped, consumer income expectations have not. Aggressive wage demands from workers remains the biggest obstacle to moderating inflation. Average hourly earnings for U.S. workers have been increasing at an annualized rate of more than 5%, double the average rate of wage growth experienced over the past decade. The labor market continues to be very tight, with unemployment close to the recent low of 3.5%.
And last, but certainly not least, let’s look at money supply. Because inflation is a monetary phenomenon, the supply of money in the economy is a critical determinant of inflation. The dramatic tightening of monetary policy by the Fed has essentially halted the growth of the money supply since early in the year. By reducing the basic monetary fuel that feeds inflation, the Fed hopes to bring inflation back down to a more acceptable level. However, it’s likely that it will take some time for tightening financial conditions to mitigate the long-term impact of fiscal stimulus and money injections from the Fed during the pandemic.
Interest rates have been pushed to levels not seen in 15 years due to the Fed’s rate increases, mortgage rates have more than doubled over the past year, and sharply higher interest rates are showing signs of meaningfully slowing the economy, especially the housing sector. These high interest rates are slowing economic activity as intended by the Fed; however, it will take some time for this moderation to show up in the lagging inflation statistics.
To sum it up, the outlook for inflation remains challenging. Expect inflation to remain uncomfortably high well into next year. Although commodity prices have come down and consumer expectations for inflation have become more benign, the Fed won’t slow or pause its rate hikes until the labor market shows signs of moderating. The Fed has been clear that it will continue with a restrictive monetary policy until inflation shows clear movement back toward its long-term target of 2%, which is far below current levels.
We are forecasting that the bear market will continue into 2023, which leads to the question: when will it end? There are some important conditions that need to be in place before the markets can fully recover:
First, inflation needs to show signs that it is not just moderating but is moving substantially lower. Again, in commodities and housing prices, there are some very early indications of moderation, but the labor market needs to show signs that spiraling wage demands are diminishing. Unfortunately, this means unemployment levels need to move higher. So, as of now, these signs of moderation don’t suggest that it will be to an extent yet that will be immediately favorable to the market.
Second, and closely tied to inflation, is the Fed’s reaction to inflation, which needs to take two forms: less hawkish rhetoric and a clear indication that it is done raising interest rates. As discussed, the Fed has indicated that more increases may come into 2023. Global stresses and growth of the U.S. dollar may be early signs that the aggressive policy actions are having some significant effects. However, the Fed is not yet ready to pivot to a more accommodative stance.
Third is the bond market. It had shown signs of improvement during the first part of the 3rd quarter, as interest rates and credit spreads moved lower. However, the bear market in bonds resumed. The bond and credit markets need to stabilize before the stock market can decidedly emerge from this bear market. Short-term bond yields have already factored in 125 basis points of additional Fed tightening. Credit spreads, although weak, have not widened in a disorderly sell-off and remain well below recessionary levels.
Looking at bear markets historically, they tend to last about a year, with an average peak-to-trough decline of about 32%. This bear market has reached about 75–80% of those historical metrics. If history repeats itself, this bear market could be expected to have run its course roughly around the 1st quarter of 2023. This timing also would align with the Fed’s projections of when short-term rate hikes will be ending.
So, with the bear market promising to dominate the 4th quarter, what should we expect from the key market sectors?
When it comes to rates, we expect the Fed to pause early next year and cut rates later in 2023. The Treasury yield curve should remain inverted, as short-term rates remain anchored by Fed rates and longer-term rates stabilize and then decline, reflecting slower economic growth.
Looking at equities, we expect that the uncertainty over the path of inflation and interest rates will diminish toward the end of the year and into the first part of 2023. That should set the stage for markets to recover. Historically, equity markets have not had sustainable rallies out of bear market lows until the Fed has stopped raising rates and begun cutting rates.
And finally, credit sectors, such as investment-grade corporates and high yield bonds, offer attractive yields not seen in years. Credit spreads, an indicator of default risk, have widened but remain below recessionary levels. We expect spreads to widen into next year as the economy slows before stabilizing and rallying. We are closely watching credit spreads as they often foreshadow equity moves.
Before we go, remember: bear markets eventually do come to an end. Patience and discipline are required to wait out these difficult periods.
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All information and representations herein are as of October 7, 2022, unless otherwise noted.
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Any indexes discussed are unmanaged and do not reflect the typical costs of investing. Investors cannot invest directly in an index.
Past performance is not necessarily indicative of future results.
Actual investment decisions made by Thrivent Asset Management, LLC will not necessarily reflect the views expressed. This information should not be considered investment advice or a recommendation of any particular security, strategy or product. Investment decisions should always be made based on an investor's specific financial needs, objectives, goals, time horizon, and risk tolerance.
Thrivent Asset Management, a division of Thrivent, offers financial professionals a variety of investment products to help meet their clients’ needs. Thrivent Distributors, LLC, is a member of FINRA and SIPC and a subsidiary of Thrivent, the marketing name for Thrivent Financial for Lutherans.