We want to start this commentary with a quick note about the hurricane that hit Florida and other areas of the Southeast U.S. last week – our thoughts and prayers are with all those who suffered loss and we wish them the best as they dig out, and rebuild, from hurricane Ian. None of what we discuss here matters in the face of a disaster like that.

Whiplash!

That may be the best word to describe the third quarter this year. July was awesome, August was a reality check, and September was a horror story. At times, this year it has felt like we have been on a thrill ride at an amusement park – and I am not talking about the Dumbo ride at Disney World. A better example is the ride my son and I went on during a father-son vacation prior to his starting college several years ago. We went to Cedar Point in Ohio (an amusement park largely known for its roller coasters) and rode their most daring ride yet (at that time):  Top Thrill Dragster! The recently closed ride started with a shotgun blast getting up to 120 mph very quickly at which point you would shoot more-or-less straight up into the air, reach a pinnacle at approximately 430 feet, and then plunge more-or-less straight down until you reached a gradual slope heading back to the start. Just watching it was scary enough, but then you learned that if the ride did not gain enough speed, it would not be able to cross over the pinnacle. It would then send the terrified riders sliding backwards to the beginning, at which point it would be shot out again.

Kind of like the markets at times this year, we seem to head on a higher trajectory only to realize we do not have the fundamentals to get us over the top. And the ride going up is met with all kinds of fears such as inflation, interest rates, shortages, and war that just want to push us back down again. Once we get a handle on those things (and if the Fed does not tighten so much that they push us into a deep recession), the thrill of getting over the top will be a phenomenal feeling. Let us hope we don’t have to face any more horror stories as we unfold October and head towards Halloween!

Financial Markets

Halloween came a month early this year to the detriment of investors. It all went south when the inflation reading for August came out and the number was worse than expected, causing fear that the Fed would raise rates higher and faster than anticipated. July was a great start to the third quarter, but September was an awful end. The equity markets all posted losses ranging from a negative 8.76% for the Dow Jones Industrial Average to a negative 10.44% for the NASDAQ.

The fixed income markets had one of their worst months during this worst of all years as the Bloomberg U.S. Aggregate Bond index shed 4.32%. There has been little to no place to hide as all major indices have entered bear market territory this year, led by the NASDAQ at -32.00% and the EAFE at -28.88%. Keeping with the Halloween theme, it seems now that the July performance was more akin to a Dead Cat Bounce (a brief rally during a bear market) than a true recovery.

The good news going forward is that opportunities have been, and are, being created in the bond market with yields where they are at, and equities are certainly nearer to the bottom than they were just a few weeks ago. A case in point is how the decline in the markets is starting to spread across size, sector, and asset class. Usually, as you approach a bottom, you begin to see this happen.

Again, it does not mean we are at the bottom, but that we are certainly closer to it than earlier this year. Expect volatility to remain high as we get variable comments from the Fed and variable reports on inflation. For more market and economic data, please see the end of this commentary.

The Economy

Uncertainty is the issue right now. Are we in a recession? Have the markets bottomed? Will prices ever come back down? And so on. It is a feeling a lot like I had watching that rollercoaster (and even more so when I was on it). Would it actually make it to the top and go over? If I went on it, would I survive it? Would I look like a wimp to my son if I did not go on it?

Uncertainty is not a great feeling. The difficulty is getting past what is happening in terms of inflation and interest rates. Yes, they are having an impact on the housing market (mortgages) and personal finances (gas, food), but in contrast to most slowdowns, the jobs picture is quite strong (wages are up), industrial production is still fairly strong, and the consumer is still spending. A mixed bag but the focus is squarely on inflation and the Fed’s reaction to it and both of those items are getting more volatile and more publicity which is feeding the doom and gloom message.

At this point, we are not in a recession and likely will not be until mid-2023 or beyond. We are just going to have to get used to that uneasy feeling as we get on the rollercoaster and shoot out of the gate heading towards the top. We will get over the top at some point, but it will be somewhat of a rocky ride in the meantime.

GDP (Gross Domestic Product) – GDP fell at an annualized rate of 0.6% in the second quarter after falling 1.6% in the first quarter. Third quarter GDP has been estimated in the 1.6% to 3% range. All numbers may be revised in coming days as the government evaluates the data further. Full year estimates have been all over the map but are currently running in the positive 1% to 2% range.

Inflation – Inflation moderated slightly to 8.3% in August which would have been great news had the core inflation (less food and energy) number not shocked everyone. That number rose 0.6% in August which was much larger than anticipated. This poor reading sent the stock and bond markets reeling and the Fed off to sharpen their hawkish tone. While expectations are that inflation will begin to taper, the impact of a higher level (than desired) for longer is a reality that is setting in for many now.

Unemployment – Somewhat steady as she goes as jobs are still plentiful and wages have continued to rise. We still have a long way to go to get back to the employment levels we saw pre-COVID, but progress is being made. Unemployment is at 3.7% and there are still more job openings listed than people to fill them. Watch this space for future developments and their direct relationship with how the economy is faring.

The Fed Watch

While inflation is the key, all eyes are really focused on the Fed and what they are doing and will be doing to bring down inflation. With the dour news on inflation in August, the Fed reiterated their hawkish tone in September and raised rates again by 75 basis points. All those expectations of the Fed stopping at 3.00% - 3.50% by the end of the year had already been dashed as the new target became 3.50% - 4.00% and it appears that will no longer be the case either.

Expectations are now that the Fed will take rates from the current 3.00% - 3.25% level to 4.50% - 5.00% by early next year after raising rates 75 basis points in November, 50 basis points in December, and 25 basis points at the Fed’s first meeting in 2023. At that point, it is widely expected that they will pause to see how inflation reacts over the early part of the new year.

It is worth noting that there are some who are arguing for the Fed to stop after their next rate hike in November as the soaring dollar could cause major market disruptions if things continue the way they have. Noted investor Ed Yardeni is in that camp and highly regarded Wharton Professor Jeremy Siegel has been very outspoken about the Fed’s extreme hawkish tone and the need for them to cool their rhetoric. While it remains to be seen what will happen, it is true that the Fed rarely gets things right and that is true this time around as they got themselves way behind the curve and now may push too strongly to get ahead of it. Not sure if “thrill” is the right word for this ride but hang on and hope we get over that hump soon!

Outlook/Summary

Opportunities always present themselves in times of major market movements and this time is no different. New opportunities exist in the fixed income markets due to the rise in interest rates and the ability to start enjoying some yield again. Soon, it will be time to extend durations a bit to enjoy that yield and to take advantage of potentially falling rates (not dramatically) once things settle down.

On the equity side, it still pays to be defensive with a value tilt although many traditional growth investments are trading at valuations not seen in quite some time. We will remain diversified but keep a focus on some downside protection as it avails itself. Our eyes, like everyone else’s, are on the Fed, the economy, and other news, to make informed decisions.

To discuss your portfolio, please call the Wealth Management department of the Lake Ridge Bank at (608) 826-3570. We look forward to speaking with you soon.

Market/Economic Data

As of September 30th, 2022…. (Unemployment data is through August for national, August (preliminary) for both Wisconsin and Madison, inflation data through August):

Thank you for your business – we look forward to speaking with you soon. (Note – this commentary used various articles from JP Morgan, Morningstar, the Wall Street Journal, Investor’s Business Daily, Northern Trust, CNNMoney.com, msn.com, Kiplingers.com, nytimes.com, Fidelity Investments, American Funds, LPL Financial and other tools as sources of information)