As we embark on our Q4 client meetings, the general sentiment is clear: most view the glass as half empty. But, if we pause for a second, a handful of factors indicate the glass is half full. Continue reading to get our take on the improvements in the macroeconomic outlook.
How To Put This In Perspective
If we reflect on our lifetimes, would you still invest knowing these economic repercussions were on the horizon?
- Gulf War
- Dot-Com Bubble
- 9/11 Attack
- Great Financial Crisis
- U.S. Credit Rating Downgraded from AAA
- Global Pandemic
Despite these events, the market continues to reach new highs over time – this is human intuition and innovation at work. As you can see, economic turmoil is a constant recurrence. Nevertheless, the media only highlights the worst-case scenario.
This constant barrage of negative headlines doesn’t allow us to consider the glass half full. So here are a few positives worth noting as we sit here today:
- Banks are in strong financial condition.
- Supply chains are healing.
- Housing prices are falling, which is good for stocks considering the impact on CPI (inflation).
This last factor will take a while to impact CPI, but it’s notable because it confirms that numerous disinflationary forces are building in the economy.
Market Perspective
- We continue to favor value over growth as rising market interest rates weigh on the multiples of long-duration equities, and investors pursue cash flows, near-term EPS, and dividend yields.
- We’ve made a handful of tactical (short-term) shifts in the portfolios this year, resulting in more strategic (long-term) shifts between equity sectors and styles. We believe getting out of equities altogether would be catastrophic to our client’s long-term goals.
- The strong U.S. dollar is a tailwind for small-cap stocks, which are less affected by the adverse effects of currency translation on the profitability of the more internationally exposed large-cap stocks.
Economic Perspective
- The Fed will likely raise rates by an additional 75 basis points at its next policy meeting on November 1st and 2nd. This would be the fifth raise resulting in a range of 3.75% to 4.00%, the fastest pace since the Paul Volker led Fed in the early 1980s.
- The terminal fed funds rate may approach 5.0% next spring and hold near that level for the bulk of 2023.
Forward-Looking Outlook
As we enter the final quarter of 2022, an honest assessment of the macroeconomic landscape reveals that the markets and the economy still face numerous challenges. However, we don’t ignore the mild improvement in the macroeconomic outlook over the past several months.
- Persistently high inflation. We think inflation has likely peaked.
- Ongoing Fed rate hikes. The next couple of rate hikes may be less aggressive than anticipated.
- Geopolitical instability. Any reduction here would provide a surprise boost for global risk assets, including U.S. stocks and bonds.
While the outlook for risk assets remains challenged, we remind ourselves that the market has declined substantially and priced in a lot of “bad news.” Valuations on many quality companies are quickly approaching pre-pandemic levels, while the S&P 500 is trading at a valuation that is finally attractive over the longer term. When (not if!) there’s improvement in one of our three sentiment indicators, there is potential for a powerful rally in both stocks and bonds.
We Feel It Too
This is a difficult market and a complicated moment for the world, but history is clear: positive surprises can and have occurred even in difficult times like this! Through periods of similar macroeconomic turmoil, markets eventually recouped the losses and moved to meaningful new highs. There is no reason to think this time will be any different.
We understand the risks facing both the markets and the economy, and we are committed to helping you effectively navigate this challenging investment environment. Therefore, staying invested, remaining patient, and sticking to the plan are critical. We’ve worked with you to establish a personal allocation target based on your financial position, risk tolerance, and investment timeline.
Still struggling to view the glass as half full? Please do not hesitate to contact us with any questions, comments, or concerns.
All views, expressions, and opinions included in this communication are subject to change. This communication is not intended as an offer or solicitation to buy, hold or sell any financial instrument or investment advisory services.