From institutional investors to retail traders, it’s been a challenging year to navigate the worst-performing market in five decades, Bespoke Investment Group says.
“It is no secret that 2022 has not exactly been the year of the 60/40 portfolio,” the group wrote in a research note in August, referring to a portfolio of 60 percent stocks and 40 percent bonds. “This year has left nothing safe with both stocks and bonds hit hard.”
The Nasdaq is parked in what Wall Street calls a bear market—when prices fall 20 percent or more—as the tech-heavy index is down nearly 30 percent year-to-date. The S&P 500 Index also fell into a bear market, sliding about 22 percent on the year. On Sept. 26, the Dow Jones Industrial Average, with a decline of 1.1 percent, became the last of the major U.S. stock indexes to fall into bear territory.
By comparison, when President Joe Biden took office in January 2021, the markets had rallied significantly from their bottom in March 2020, when COVID-19 was declared a pandemic. The Dow had climbed about 61 percent, the S&P 500 had rallied roughly 67 percent, and the Nasdaq spiked close to 97 percent in that span. These indexes then reached their peaks in late 2021.
What’s Driving the Markets?
The three biggest drivers of this downward market have been surging inflation, aggressive monetary policy tightening by the Federal Reserve, and growing concern about global recession.Despite the summertime rebound, market analysts say that the market bounce is over.
Ray Dalio, the billionaire founder of Bridgewater Associates, reiterated that position, suggesting higher rates could further sink equity prices.
There had been some expectation that the central bank would pull the trigger on a full-point increase following a hotter-than-expected August inflation report. For now, Mimi Duff, the managing director at GenTrust, notes that investors are pricing in a peak federal funds rate of 4.6 percent around May 2023 as they digest the “higher for longer” messaging from the inflation-fighting Fed.
Instead of ultra-hawkish rate hikes, the Fed “is trying to look as tough as possible,” Christian Hoffman, a portfolio manager and managing director at Thornburg Investment Management, wrote in a note.
Stocks in the 4th Quarter
What does this mean for stocks in the final few months of 2022? It will be all about the data.The FOMC’s economic projections show that officials think the unemployment rate will reach 4.4 percent next year, and that gross domestic product (GDP) will run at an anemic 1.2 percent pace in 2023.
Following two consecutive quarters of negative GDP growth rates, which indicates a technical recession, the U.S. economy risks running another quarter of subzero GDP.
According to Deutsche Bank economists, investors will be paying attention to the final second-quarter GDP reading, the latest initial jobless claims, and the August personal income and spending data. They will be released later this week.
“In summary, Fed officials and market participants will get plenty of data to inform their views on the economic outlook. However, given the Fed’s recent rhetoric, much of it is likely to play second fiddle to the inflation data,” the financial institution explained in a note. “Continued upside surprises to inflation could lead to a peak fed funds rate exceeding 5 percent, particularly if it occurs in conjunction with easier financial conditions and a persistently tight labor market.
“Conversely, a faster decline in inflation coupled with tighter financial conditions and some loosening in the labor market, could beget a terminal rate closer to 4 percent. At this point, we see risks skewed in the hawkish direction.”
Both the Fed and the financial markets will be in “information-gathering mode at this point,” Duff noted.
“[The] Fed needs inflation lower and the jobs market closer to balanced,” Duff said. “A lot of wood to chop on both fronts, so we need to see how the real economy evolves.”
In the end, “the soft-landing fairytale”—lowering inflation without causing economic pain—is “rapidly evaporating on Wall Street,” Scott Anderson, the chief economist at Bank of the West, said in a note.
“Global equity markets as you can imagine are not swallowing the Fed’s message well and equity analysts on the street are furiously cutting their year-end price targets. So now is a good time to keep your head down and take some shelter as the Fed is about to start breaking our finest china.”