The US stock market and bond markets have both continued their downward trends, that started in the beginning of 2022. The US Stock Market, as measured by the S&P 500 is now down more than 20% and meets the definition of a Bear Market. The Nasdaq is down even more, and the bond market also continues to fall. It is the worst start to the US stock and bond markets in decades. Let’s take a closer look at the markets and what is causing this significant sell off in stocks and bonds.
In this blog, you’ll learn:
- Inflation is the Highest in Decades
- Federal Reserve Response to Inflation
- US Stock and Bond Market Reaction to the Federal Reserve, Interest Rate Hikes and Recession
- Positioning your Portfolios for a Bear Market
- Let’s Look at the Glass Half Full
- What is our FJP Strategy?
Sign up for our email newsletter for views of the economy, stock market, and top news stories from our Wealth Managers at Financial Journey Partners.
Inflation is the Highest in Decades
The Bureau of Labor Statistics reported that the Consumer Price Index (CPI) for the past 12 months ending in May, increased 8.6%1.
Source: Labor Department and The Wall Street Journal2
The US CPI in May reached its highest level in more than four decades, as surges in energy and food prices pushed prices higher.
Source: Labor Department and The Wall Street Journal2
We can see the impact of inflation every day when we buy things online or at a store.
Federal Reserve Response to Inflation
For a quick recap on inflation:
June 2021: Fed Chair Jerome Powell at testimony before Congress, discussed issues such as supply bottlenecks and the ongoing Covid pandemic that caused prices to go up in categories including cars, airplane tickets and hotel rooms. He said “the incoming data are very much consistent with the view that these factors will wane over time and then inflation will move down towards our goals”3.
November 2021: Fed Chair Jerome Powell again at testimony before congress said “We tend to use the word transitory to mean that it won’t leave a permanent mark in the form of higher inflation. I think it is probably a good time to retire that word and try to explain more clearly what we mean”4.
December 2021: Mohamed El-Erian, Allianz Chief Economic Advisor said “The characterization of inflation as transitory is probably the worst inflation call in the history of the Federal Reserve, and it results in a high probability of a policy mistake”5.
Inflation is like a runaway train
The Federal Reserve’s response to reduce this historically high inflation has been to raise the Fed Funds rate from 0 to 0.25% in March and to 0.75% in May. They were expected to raise interest rates another 0.5% in June, but with the May CPI inflation rate at 8.6%, the Federal Reserve changed their plan and raised interest rates by 0.75%, to 1.5%. The Federal Reserve is expected to raise interest rates again 0.5% or 0.75% in July.
Because the Federal Reserve called inflation transitory in the Summer of 2021, and did not start raising interest rates until March 2021, inflation has surged to 40-year highs. An analogy is if the economy were a freight train, it would take a lot more than lightly tapping the breaks to get it to slow down. The Federal Reserve is now in the position of having to slow down a runaway freight train (a high inflation economy), and they are expected to aggressively raise interest rates to do that.
Aggressively raising interest rates has investors concerned that the US economy is headed towards a recession, which is two consecutive quarters of negative GDP. The US economy had a GDP of -1.5% in Q1 of 2022. In July, we will find out if the GDP in Q2 was also negative, and if it is, then we will meet the technical definition that a recession is already underway.
We are already seeing signs that rising interest rates are pushing the US economy into a recession, including:
- Tech companies have already announced layoffs
- Mortgage companies have also laid off employees since the rising interest rates has resulted in a significant reduction in the number of new mortgages issued
- The housing market is already seeing a slowing of sales and prices are beginning to fall
- Consumers beginning to reduce their spending for discretionary items as they have less money to spend, and must spend more because of high gas and food prices
- Potential of reduced profits when companies start to report their Q2 financial results in July and August due to rising energy prices, rising wages for employees, rising raw material costs, as well as shortages of products from China (due to lockdowns in China).
US Stock and Bond Market Reaction to the Federal Reserve, Interest Rate Hikes and Recession
US stock market investors have reacted to rising interest rates and increasing chances of recession by selling stocks. Many stocks are at 52-week lows and down over 50% from their highs. Even large institutions are not buyers at this point and the largest investment company in the world, BlackRock, announced on June 13:
“We’re not buying the stock dip because valuations haven’t really improved, there’s a risk of Fed overtightening, and profit margin pressures are mounting”6.
When large institutions like BlackRock are not buying stocks, that can be a driver to push the stock market lower.
Let’s take a look at the US bond market. A recent article in The Wall Street Journal was titled: “It’s the Worst Bond Market Since 1842. That’s the Good News”7.
The measure of the US Bond Market, the Bloomberg Barclays US Aggregate Index, also continues to fall as the Federal Reserve increases interest rates and is down almost as much as the US Stock Market. With the Federal Reserve expected to aggressively raise interest rates more this year, we think the bond market will go even lower.
S&P 500 vs Bond Market:
Source: HiddenLevers.com as of 6/30/22 Intraday
Positioning Your Portfolios for a Bear Market
In January of 2022, our analysis of the US bond market was that it was likely to have a very bad year due to the aggressive interest rate increases by the Federal Reserve. We sold all the bond funds for our clients earlier in the year and that money is now sitting in cash (money market fund) in your accounts. We have also sold many stock positions for clients to book profits and mitigate risks. These proceeds have also been moved to cash, so client accounts are sitting very high in cash at this time. This is helpful during these days in the stack market that are down 3 and 4% and hopefully this allows our clients to sleep easier on these difficult days in the markets.
Bear Market Rallies
One of the characteristics of a bear market are rallies inside the bear market. The chart below shows the rallies in the S&P 500 in 2022:
So far this year, we have seen four rallies, only to see the market turn down each time and reach new lows. This chart shows how difficult and tricky this market has been this year. There was even an 11% rally over 11 days in March, only to end with the market falling to new lows. Since that rally, there have been two additional rallies, each time lasting a shorter number of days and going up less. This makes it very difficult to try to buy any investments and achieve lasting gains in such a short period.
Let’s Look at the Glass Half Full
There are some positive things happening as a result of the correction in the markets:
- The stock of some of the best companies in the world are now significantly lower. We are watching for the point where we can purchase these companies at great prices
- The stock market correction in 2020 provided an opportunity to buy stocks with low prices, allowing for nice returns in 2020 and 2021
- The bond market is now lower than it was during the correction in 2020 and headed down to the prices of bonds during the 2008 financial crisis. This could result in an opportunity later in the year to buy bonds at the best prices in several decades
- Plus, new bonds are being issued with higher interest rates that have the potential to increase the yield and return of bond funds
What is our FJP Strategy?
Since the beginning of 2022, we have taken many steps to mitigate risk in client portfolios:
- Sold ALL bond funds earlier in the year as they started trending down, as our expectation was that additional interest rate hikes by the Federal Reserve would drive the bond market down further
- Sold several stock investments to take profits, or when they hit our stop loss levels, to preserve principal
- Replaced higher volatility growth investments with lower volatility value companies, including high dividend companies
- Daily monitoring the stock and bond market to watch for a market bottom or good buying opportunities
- Creating our buy list of what investments to purchase for clients when we think the time is right
2022 has turned out to be a very difficult year in the stock and bond market. We are monitoring the economy and markets daily to actively manage your accounts during this highly volatile period. If you have been watching the news or markets on TV, we recommend take a break and focus other things you enjoy. We want you to know that we are working hard every day to manage your investments for you.
If you have questions on how the topics in this article could impact your portfolio, give your Wealth Manager a call.
Financial Journey Partners - Partners in Your Financial Journey®
Our Financial Journey Partners office is based in San Jose, California. We have clients that live in many states across the country. If you have questions about your investments or financial situation, call us to schedule time to talk about your specific situation.
Sign up for our email newsletter to stay up to date on our views of the economy, stock market, and top news stories.
1 Bureau of Labor Statistics – Consumer Price Index, May 2022
2 Wall Street Journal – Stock Market News Inflation Consumer Price Index, May 2022
3 AP News – Fed’s Powell says high inflation temporary, will ‘wane’
4 Yahoo! News – Fed Chairman Jerome Powell retires the word 'transitory' in describing inflation
5 CNBC – El-Erian says ‘transitory’ was the ‘worst inflation call in the history’ of the Fed
6 Seeking Alpha – Why We're Not Buying The Dip In Stocks
7 Wall Street Journal – It’s the Worst Bond Market Since 1842. That’s the Good News.