This report is created by Cetera Investment Management LLC.
The S&P 500 went into a bear market, declining more than 20% from its peak.
The 10-year Treasury yield jumped over a percentage point this quarter, reaching as high as 3.5%. Bond returns were also negative, as prices fall when yields rise.
Headline inflation, which includes more volatile food and energy prices, surprised on the upside in May. CPI rose 8.6% year-over-year.
The Fed, which normally focuses on core inflation, started to pay more attention to the volatile headline inflation. They got aggressive in tone and action, raising rates by 0.75% in June.
Recession risks have increased as the Fed’s aggressive pace could cause policy missteps if it raises interest rates too fast and slows down the economy more than needed. The Fed is late to curbing inflation, however, and is running out of options.
Bearish market sentiment is high and upside surprises are possible. The first year of a bull market tends to offer outsized returns, so investors should stick to investment objectives.
Much of investors’ attention this quarter has been on stock markets, as the S&P 500 went into a bear market, defined by falling over 20% from its most recent high. This is unsettling for many, but it is important to see through the noise and focus on fundamentals and the longer-term outlook. Long-term stock returns are driven by corporate earnings, which are impacted by the state of the economy. Investors currently fear persistently high inflation and the U.S. Federal Reserve’s (The Fed’s) response to it. So, as investors, we must ask ourselves how these factors will impact the economy and thus corporate earnings? While complicated, the analysis might be less complex than in previous years, as the U.S. government likely won’t try to save the day by surprising investors with another round of stimulus.
The U.S. economy is slowing quickly, with growth being hamstrung by current Fed actions and the expectation of further Fed actions. We are currently seeing this in housing data, and there are fears we could be in a recession already. Higher food and energy prices may slow overall consumption.
The good news is that the labor market is currently very strong. If job losses and hiring freezes start to occur, we may benefit from unemployment starting from a very low point, which could make for a milder recession.
A recession may also be already priced into equity markets, as valuations have fallen from high levels back to their 15-year averages. Corporate earnings remain strong but will likely trend lower as inflation and slow economic growth eat into corporate profits.
In bonds, yields have risen dramatically, causing large price declines. The bond market is forward-looking, and the Fed is pricing in further rate hikes. We note that longer maturity bond yields have increased less than yields of shorter maturity bonds. If a recession occurs, longer maturity bond yields may fall due to a slower growth outlook. This could help drive bond returns that already offer much higher current yields than a year ago.
It has been a tough year thus far for investors as the markets price in recession risks. It is important to point out that recession data is historically based. In other words, we could be in a recession right now and not know it until after the recovery has started. And it is also possible to see positive equity returns in a recession as investors look to the recovery. On a positive note, bearish sentiment is currently high, which can be a potential contrarian indicator for a better entry point. Put another way, when too many people are pessimistic, that can be a sign of a market bottom. Additionally, there could be positive upside surprises if there is a resolution in the war in Ukraine and/or if the Chinese government further eases its restrictive zero-COVID policies.
We want to reiterate our recommendation to diversify across asset classes, sectors, and countries while adhering to the long-term risk and return objectives.
our financial professional can help you stay on track and keep focused on your personalized long-term plans, helping you navigate this market volatility.
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About Cetera Financial Group®
“Cetera Financial Group” refers to the network of independent retail firms encompassing, among others, Cetera Advisors LLC, Cetera Advisor Networks LLC, Cetera Investment Services LLC (marketed as Cetera Financial Institutions or Cetera Investors), Cetera Financial Specialists LLC, and First Allied Securities, Inc. All firms are members FINRA / SIPC. Located at 655 W. Broadway, 11th Floor, San Diego, CA 92101.
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