The broad US stock market indices finished down for the third quarter in a row with the S&P 500 coming in at minus 24.77, the Nasdaq down 32.40% and the Russell 2000 down 25.19% year to date. In bear markets, surprises tend to be to the downside so we do expect some elevated volatility in the short term. However, we do think that more of the stock market carnage is behind us than in front of us. Historically, bear markets associated with a recessions have averaged drawdowns of about 33% and we don’t think this one will be worse than average. We say this because while there are some cracks in the armor, the fundamentals of the US economy remain strong. For example, the job market has remained resilient and US banks are in decent shape. This isn’t 2008. While there are plenty of hazards on investors’ radars – Nordstream Pipeline sabotage, war in Ukraine, supply chain disruptions and falling housing prices to name a few – we think the dominant force behind current stock price declines is the Fed’s well telegraphed war on inflation. When aggressive Fed action moderates, or more specifically, when the markets sense that it is moderating, we think the secular bull market can resume. So when will that be?
The table below plots market expectations about the future of Fed policy.As of September 30, 2022, the market is placing a 71.1% probability of a 75 basis point hike in November, a 66% probability of another 50 basis point hike in December and a 64.4% chance of a 25 basis point hike in February for a total 150 basis points more in rate increases.The Fed Funds Rate has already risen by 300 basis points so most of the hikes appear to be behind us and practically all of the hike for this cycle should be in the rearview mirror by mid-December.Because markets are forward looking discounting mechanisms, stocks usually bottom when or before the economic landscape looks its worse.As of this writing, we are taking advantage of higher interest rates by aggressively purchasing short term treasuries for our clients.We are currently holding elevated levels of cash while preparing our stock buy list for the next bull leg up.
