The third quarter of 2022 saw the capital markets continue their march downward with both the stock and the bond markets showing weakness. During market conditions like these, I am often reminded of a bit of wisdom I heard during the 2008 Global Financial Crisis; “There is only one end of the world, and this isn’t it.” Perhaps paradoxically, the more prognosticators who predict the complete collapse of the economy and the markets, the closer I think we are to turning the corner. A well-documented aspect of humanity is the notion of “recency bias.” Recency bias happens when we give more credence to recent events than we do over historical ones. I had a great example of this in the last few days when I saw an article loudly stating, “The economy can’t work with 7% mortgage rates!” When, in fact, we saw those same rates in 2001 and we saw rates higher than 18% in the 1970s. Let us look at what is causing the current issues and what the possible paths forward are.
As many of you have heard in our recent meetings, the current economic circumstances can almost be entirely linked back to what we did to get through COVID. The United States, as well as almost every other country that used similar tactics to fight the economic impact of the pandemic, is going through similar straights. The primary impact of those efforts has been inflation, the likes of which we have not seen since the early 1980s.
To fight inflation, the Federal Reserve is raising interest rates, making borrowing more expensive. This has started to slow the economy, but our economy is a vast, complex machine so it takes a period of time for some of the effects of the increased interest rates to percolate through the economy. We’ve already seen the beginning of a slowdown in the housing market. Automobiles are starting to slowly move down in price also. Companies are starting to build inventories, which means they have goods they either cannot sell or cannot sell at the price they want to. The one area of the market that is continuing to show resilience is employment, although companies are still experiencing problems hiring. The danger with trying to slow the economy is things may start to slow gradually, as we are seeing now, but then suddenly get much worse.
Much of the uncertainty around the economy and the rise in interest rates may already be reflected in the recent weakness we’ve seen in the capital markets (both stocks and bonds). There is a distinct likelihood of continued weakness as the economy not only recovers from the drastic measures untaken to get through COVID but also from the realities of our ever-changing world.
Speaking of our ever-changing world, our outlook in the United States is much stronger than what we are seeing in the rest of the world. Europe will be struggling with energy issues for a few
years as they wean themselves off Russian natural gas and cope with the other consequences of the Ukraine-Russia conflict. China is dealing with several internal issues, especially related to its property sector, which is a key part of its economy. China, once the world’s workshop, is being increasingly replaced with other lower-cost options, including the United States re-onshoring production. All this uncertainty in other parts of the world, along with our higher interest rates, has caused the value of the U.S. Dollar to basically skyrocket compared to other currencies. This is great if you want to import something or travel overseas. However, if you are exporting goods from the U.S., it is almost debilitating to your business.
As we look forward, we do see continued volatility into the fourth quarter of 2022. However, there is a distinct possibility of some relief later in the quarter. As we move into 2023, we expect a return of volatility at the beginning of the year, but then for the markets to find some footing as we move deeper into the year. For investors, we continue to advise keeping the funds you need for the short-term in cash or shorter-term fixed income and riding out the volatility with your longer-term investments. As always, if you have questions about your portfolio, please reach out to us.
Kevin P. Sullivan, CFA, CFP®, AIF
1229 Lake Plaza Drive
Colorado Springs, CO 80906