Market Data for the quarter ended September 30, 2022:

  • S&P 500 Stock Index: 3586, down 5.26%
  • Ten-year Treasury Note Yield: 3.80%, up .83%
  • Gold: $1,672 per ounce, down 7.3%
  • Oil: $79 per barrel, down 25%

After surging in July off significantly “oversold” price and sentiment conditions in June, US stocks and bonds faced accelerating losses in the final two months of the third quarter. This about-face was driven by a delayed recognition from both the Federal Reserve and investors that significantly elevated inflation 1) is entrenched in the economy, and 2) will require aggressively restrictive monetary policy to eliminate for some time to come.

Our view is that this is a welcomed development in that unless the Federal Reserve and investors take inflation seriously, the economy will face a future of decreased stability and growth. To our chagrin, however, investors concluded that the proper course of action was to pile into liquidity-dependent, expensive stocks heavily exposed to the economy (such as Apple, Amazon, and Tesla), while dumping low-priced shares in companies relatively insulated from economic conditions (such as Kimberly-Clark, Pfizer, and Verizon).

Fortunately, such absurdly irrational behavior on the part of “investors” is unlikely to be a permanent feature of markets and will therefore likely be reversed to the benefit of our customers’ portfolios. We view this as a near inevitability and are therefore highly optimistic for our customers’ investment performance in the years ahead. Conversely, the owners of expensive, so-called “growth” stocks are likely facing years of disappointing, if not outright dismal returns.

To further elaborate on our confidence, while we view a recession in the US economy as highly probable, we do not consider the resulting distress to be any sort of threat to the long-term health of our portfolio companies. Consequently, when the economic storm inevitably passes, their share prices will likely rebound quickly. This was our experience coming out of the bear markets of 2000-02 and 2007-09, and we see no reason to expect anything different when the bear market we are experiencing today comes to an end.

Moving on to the broader market, we anticipate further volatility and probable declines as investors continue to come to grips with the gravity of the inflationary situation. As per the discussion above, we see market risks concentrated in expensive “growth” shares, in which the last hold outs of reality deniers have barricaded themselves a ’la the Germans at Stalingrad (not good). An interesting development to look out for will be the Fed’s reaction to a likely broad-based contraction in economic activity, particularly in employment, with inflation still possibly running well above their 2% target. Will the Fed “blink” or “stay the course” in rooting out inflation? We don’t know the answer to that question, but answering it will be the obsession of the financial media.

Finally, we view the developing situation in Ukraine as a cause for concern. If Vladimir Putin continues to suffer humiliating defeats on the battlefield to Ukrainian forces, which we feel is likely, there is a small but real possibility he could resort to employing chemical, biological, or even nuclear weapons. Such an event would almost certainly lead to widespread investor panic. This is by no means our base case scenario, but it is nonetheless a risk we must remain cognizant of.

For the remainder of the year, we see the stock market, as represented by the S&P Five-hundred stock index, trading in a range of 3200 to 4000. It finished the third quarter at 3586. The final quarter of the year is typically a strong one for markets given its inclusion of holiday cheer and optimism for the year ahead. This clearly isn’t a typical market, however, so a festive ending to the year is by no means guaranteed or even probable.

As always, we appreciate your business and the confidence you have placed in us.  Please do not hesitate to contact us with any questions or concerns regarding you may have regarding your investments.