As the quarter comes to a close the financial markets have served a cold reminder to investors, as bond and equity markets fall in tandem, there are few places to hide. Year-to-date we’ve seen a decline in the S&P 500 of -23.62% while U.S. Government Bonds fell -14.93% and Investment Grade -16.77%. The decline in what investors believe to be conservative assets with lower exposure to risk, has left many investors questioning on whether the financial markets have found the floor. Unfortunately, research suggests the worst is yet to come. In this month’s issue of The Samra Report we discuss factors impacting the markets and share potential areas of opportunity.
With Federal Reserve Chairman, Jerome Powell, attempting to tame inflation with the only tool at his disposal: interest rates. FOMC meetings have turned into a game of Russian Roulette as each rate hike causes financial markets to test new lows. What started with inflation being transitory, has prompted the Fed to back-peddle, flipping the script on the definition of transitory, causing fear-induced fund outflows. A tight monetary policy: hiking interest rates to combat run-away inflation only impacts the demand side the equation, resulting in real negative economic impact. Similar to how recessions are not uniform geographically or by sector, this blanket response to inflation could negatively impact key areas:
Widening the Wealth Gap
Low-income households who may have had their sights set on a home purchase in the near future will be priced out of the real estate market. A recent NY Times article stated: the typical monthly mortgage payment is now roughly $2,352, up 66 percent from $1,416 a year ago, taking both higher home prices and interest rates into account. Not accounting for potentially higher closing cost, property taxes, insurance and mortgage insurance which is often required on down payments of less than 20 percent.
Foreign Trade
On the most fundamental level in economics, when a domestic economy raises interest rates relative to foreign economies. This action leads to an influx of capital purchasing financial instruments of the domestic economy, resulting in a stronger domestic currency. A strengthening dollar not only weakens foreign trade, however, can negatively impacts domestic corporations yielding revenue from abroad.
Aging population and COLA
For conservative investors, typically those retired or nearing retirement age, with a greater allocation towards fixed-income investments like bonds. The impact of rising inflation and lost bond valuations due to increases in interest rates have served a 1-2-punch of lower wealth and higher costs. In August 2021, Samra Wealth Management reiterated our concerns: “Conservative investors in search of yield, in an interest rate environment where the 10-year fell below 1.14% in July, and the real interest rate (10-year U.S. Treasury indexed for inflation) fell to -1.19%, a multi-decade low, need to rethink their investment strategy.”
Technically, the United States is not in a recession as recessions are officially declared by the National Bureau of Economic Research. At Samra Wealth Management we believe the worst is yet to come, as the Fed may reach it’s 4% Federal Funds rate target during their November meeting, and it is unlikely they would deviate from the plan with rate reductions in 2023. Foreign trade has already shown signs of weakness, with international orders decreasing due to a strong dollar, however, the situation in Russia could wreak havoc on supply chain and availability of materials.
The Russian squeeze on natural gas could see parts of Europe go into a government mandated lockdown, in an effort to sustain reserves. According to Eurometaux in a letter to EU Commission President, Ursula von der Leyen, about 50% of EU aluminum and zinc production capacity has already been forced offline due to the power crisis.” Although the United States may see increased volatility in energy, building and manufacturing supplies, we believe the impact to consumers will be transitory. With Union favorability at a 60-year high, a case could be made for higher wages for longer, however, with U.S. corporations painting a bleak picture for 2023, industry leaders have signaled hiring freezes and layoffs, countering the impact of wage inflation. At Samra Wealth Management, we believe risk of recession to be imminent in the first half of 2023, however, with recession indicators being lagging, there’s reason to believe we may be out of recession territory prior to a recession being announced.
With inflation at levels not seen since 1981, eroding the value of consumer savings, investors are having to pick their poison: losing value in the stock or bond markets, or holding cash as purchasing power erodes. For concerned investors, we believe there are a number of opportunities, however, we expect market gains to be paired with greater than average volatility.
If you are a conservative investor, you may want to consider investing in a 1-5 year municipal bond ladder, through a separate account manager. For investors with a greater appetite for risk, consider diversifying in Technology, Healthcare, Consumer Staples, Materials, Energy, Industrials, decreasing allocations towards financials and real estate. According to Factset “industry analyst project more than 25% increase in the S&P 500 over the next 12 months”, and the article predicts select areas can expect to see greater gains (Communication Services 37.6%, Information Technology 31.3%, Real Estate 30.8%). You should always consult with your investment professionals for specific guidance pertaining to your situation
In the near term the Fed, the Russian squeeze on natural gas, the Chinese real estate crisis and the sterling in freefall will undoubtedly cause shockwaves for global markets, however, we believe these factors will provide an opportunity for global diversification, later in 2023.
Disclosures:
This material is provided as a courtesy and for educational purposes only. This does not constitute a recommendation or a solicitation or offer of the purchase or sale of securities. Please consult your investment professional, legal or tax advisor for specific information pertaining to your situation.
All information contained herein is derived from sources deemed to be reliable but cannot be guaranteed. All economic and performance data is historical and not indicative of future results.
All views/opinions expressed herein are solely those of the author and do not reflect the views/opinions held by Advisory Services Network, LLC.
Investing involves risk including loss of principal.
Investment advisory services offered through Samra Wealth Management, a Member of Advisory Services Network, LLC
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