In my last quarterly letter, I stated that in a couple of years, we would not remember the specifics of this particular economic time, with the exception that it was a time when we could’ve bought in. That part hasn’t changed.
In the third quarter, we saw an inverting yield curve and a significant recessionary sign. The Federal Reserve is fighting to put us in a recession. They believe that the only way to slow down rampant inflation is to create a crawling economy, in which very little money is traded. They are increasing interest rates, decreasing their balance sheets, and causing the market to react as such.
YTD returns as of September 30, 2022.
| DJIA | -19.72% |
| S&P 500 | -23.88% |
| Nasdaq | -31.99% |
However, it is not all bad. Traditionally, equity markets in recessions follow a similar track:
- Price/Earnings (P/E) Compression— The market is priced (among other ways) on a P/E scale. To put it simply, take the stock price and divide it by the annual earnings. P/E compression means investors may think stocks are too expensive and will sell until the price is low enough to be in line with their future earnings.
- Negative Earning — A company posts negative earnings for the quarter. We have started to see earnings growth estimates plateauing, so this seems in line.
- Negative GDP — It is a recession.
Rarely has a recession started before or while the Fed increased interest rates. Assuming there will be another two hikes this year, I predict a technical recession in the second quarter of 2023. Typically, a recession lasts ten months, so 2023 looks to be shaping up to be a difficult year, economically speaking.
Market-wise, longer than average through the year. It is abnormal to have so much negativity in the stock market for the entire year. Call me an optimist, but I hope to see a little reversion to the mean by the end of the year.
Home sales are down, interest rates are up, and affordability is through the floorboards. This should create a period of a significant real estate stalemate where many buyers can’t afford houses at elevated prices, and many sellers are unwilling to sell at the buyers’ demanded prices.
In these times, the unemotional usually comes out on top. Allowing the markets to work through these cycles to get to the other side and back on track is prudent. However, for those with the stomach for some short-term volatility, buying quality companies with solid balance sheets and a wide moat in their respective business can (and in the past does) prove to be a very profitable investment thesis. I strongly encourage those clients that have a growth investment goal to add to their portfolios in these difficult market times.
On a personal note, my wife, Erika, and I are expecting our second child in early November. We are both incredibly excited, grateful, and over the moon.
What I am watching:
- Federal Reserve notes in the third quarter
- S&P to bounce back and end the year within 10% of its highs and revert back to the mean
- Insurance rates on long-term care and death benefits to be revised lower
- Insurance contracts are priced based on mortality risk and the costs to hold such risk for each insurance company’s risk pool (the amount and type of people they insure). Much of their cost savings come from short-term and risk-free investments, namely Federally Guaranteed Treasuries and CDs.Interest rates have risen dramatically and will continue to do so, increasing the earnings on the insurance companies’ investments, thereby offsetting some of the mortality cost of their insured pool. Read: Returns go up, Costs go down. Maybe I’m wrong, but I believe insurance costs may drop considerably in the next six If so, it would be a great time to revisit that old insurance policy you forgot about.
- House of the Dragon, obviously
- An infant during the holidays
Enjoy the holiday season, everyone. Your fourth quarter planning meeting invite has already gone out, so please take the short questionnaire and schedule your meeting. As always, please contact me with any questions or concerns.
Philip Clark, CPWA®, CFP®, CLU®| Director – Wealth Management
Direct: 626.788.3947 | philip.clark@krostwealth.com
This information should not be construed as tax advice, nor should be taken as financial planning advice. Please consult your tax professional. These opinions are based on observations and research and are not intended to predict or depict performance of any investment. These views are as of the close of business on 10/31/2022 and are subject to change based on subsequent developments. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. These views should not be construed as a recommendation to buy or sell any securities. Past performance does not guarantee future results.