Market Commentary 6/21/22

Stocks fell to new year-to-date lows last week amid rising recession fears, central bank policy expectations, and disappointing economic data. We saw the Dow cross below the 30K level for the first time since early 2021. The wealth destruction has been devastating. We are experiencing the largest drawdown for bond and stock markets in tandem on record. Crypto currencies have been decimated, with some going to zero. The average price of a stock in the Russell 2000 small cap index is down nearly 45%.

The market’s focus on Federal Reserve policy remains unchanged as stubbornly high inflation forces the Fed to raise interest rates and shrink its balance sheet by unwinding the pandemic-related quantitative easing. The Fed’s aggressive (and unprecedented) tightening actions are increasing market volatility and causing stock and bond prices to trade lower. The S&P 500 is now in a bear market, which is defined as a 20% decline from a recent peak, and interest rates are rising to multi-year highs. The 2-year Treasury yield recently rose to its highest level since 2007 as investors expect 40-year high inflation levels will compel the Fed to remain aggressive. Mortgage rates are now back to 2008 levels, with the 30-year fixed rate mortgage exceeding 6%, up from approximately 3% at the start of the year.

There are some differences between the current tightening cycle and prior cycles. The most notable difference is the speed and size of the interest rate increases. Factoring in the 0.75% increase at last week’s June meeting, the Fed has raised interest rates 1.50% since the first increase in March. Investors expect the Fed to raise at least 0.50% at the July meeting, which would make 2022 the fastest 2.00% increase during the last five tightening cycles.

The current Fed tightening cycle has more in common with the 1988 and 1994 cycles than post-2000 cycles. We are in a market environment that investors haven’t experienced in many years. In fact, many of the current market participants have not experienced such a market (which may explain the magnitude of the volatility). There are concerns high inflation could become entrenched, as well as significant uncertainty about how high and fast the Fed will need to raise interest rates to contain such inflation. This raises a particularly concerning risk – persistently high inflation could provoke the Fed to tighten too much and negatively impact economic growth. This is one of the reasons the markets are so volatile.

As noted, inflation and the Fed’s response to it have been the main driver of weakness across asset classes. Just as we enter a bear market; however, there are signs that inflation is peaking. For example, we follow rents in New York City closely. Just a few months ago, there were auctions to rent a one-bedroom apartment, driving rent prices significantly higher. Now it appears rents have stabilized, units are staying on the market longer, and we are seeing incentives like a month of free rent being offered again. Similarly, homes that sold in just hours in Florida now remain on the market and sellers are having to cut prices to attract buyers. This is what should occur based on this year’s interest rate hikes. Housing prices seem to have stopped their one-way direction higher, slowing demand, and lowering home price inflation. Perhaps the adage, “the cure for high prices is high prices” will prove to be true this year.

We continue to hear media “experts” talk about the risk of a recession. It is our view we are likely in a recession that started with the first quarter 2022 negative GDP number. Economic data has been weak throughout the second quarter so will not surprise us if this quarter’s data is negative as well. Even if the official change in GDP, as reported by the Bureau of Economic Analysis, is positive, the trend in growth is not promising. It is also very important to remember that the “official” beginning and end of any recession is announced many months after the actual recession takes place. As a result, when the start date of a recession is officially declared, the bottom for the economy and the equity market has usually been reached.

Just as we caution investors to not chase a rising market and become more aggressive as prices rise, it is important to remain disciplined during market declines. In the past, markets have eventually come back to make new highs following a bear market. We are reminded of a quote by Warren Buffett. “Be careful betting for the end of the world, as you will only be right once.” Some of us at Oxford Harriman have been in this business since the early 1980s and have experienced several bear markets. We realize the economy and the market move in cycles. This may very well be a good time to increase your equity exposure.

We will end this commentary with some numbers. We looked at past large quarterly declines to put this year’s decline into perspective. Depending on how the rest of June plays out, the S&P 500 is on pace to experience its 9th quarterly decline of more than 15% since the end of World War II. Following the prior 8 quarterly drops of at least 15%, the S&P 500 averaged a gain of more than 6% in the next quarter. Additionally, over the next six months the gain has been over 15%. Finally, the gain over the next full year has averaged more than 25%. Of course, historical trends are not predictions of future results, but they do provide some perspective. The following quote from research performed by Bank of America will reinforce our past comments about the importance of not missing the best days in the market. “Looking at data going back to 1930, the firm found that if an investor missed the S&P 500′s 10 best days each decade, the total return would stand at 28%. If, on the other hand, the investor held steady through the ups and downs, the return would have been 17,715%. When stocks plunge a natural impulse can be to hit the sell button, but the firm found the market’s best days often follow the biggest drops, so panic selling can significantly lower returns for longer-term investors by causing them to miss the best days.”^1.

As always, please feel free to reach out to us directly with any questions.