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For the third quarter of 2022 (Q3’22), both equity and fixed-income returns were negative. Broad equity indexes such as the S&P 500 have now entered a bear market -a term used when securities prices fall 20% or more from recent highs-, while year-to-date US investment grade bond returns are the worst on record (since 1976). The biggest driver of unsettled market conditions continues to be the Federal Reserve’s (Fed’s) focus on battling inflation and its aggressive path of interest rate hikes.
After equity markets enjoyed a summer rally on hopes of a Fed “pivot,” the unambiguous message from the Fed’s annual Jackson Hole retreat in late August was that fighting inflation is its top priority. Following Jackson Hole, both equity and fixed-income markets started to decline again as Fed Chair Powell emphasized that the Fed would not stop raising rates until U.S. inflation metrics showed meaningful evidence of declining toward its 2% target. Although headline inflation eased slightly in August (CPI +8.3% YoY, vs. +8.5% YoY in July), core inflation metrics indicate that price increases have spread broadly across the economy. The Fed backed up its tough talk from Jackson Hole with another 75 bps rate hike at its September Federal Open Market Committee (FOMC) meeting. The Fed funds rate now stands at a range of 3.00-3.25%, compared to a range of 0.0%-0.25% at the beginning of 2022. Futures markets are pricing another +125 bps of rate hikes across the final two FOMC meetings of the year, implying Fed funds at 4.25%-4.50%.
In Q3’22, the US dollar index (DXY) gained 7.1% (up 17.2% YTD), and the benchmark 10-year US Treasury rate (UST10) moved up 78 bps to end September at 3.76% (up 224 bps YTD), and the price per barrel of WTI oil fell by -26% (up 6% YTD), trading at $79.9 at the end of September.
Outside of rate policy, the war in Ukraine continued. Nord Stream, a major pipeline of gas to Europe, had its flows significantly depleted as Russia curtailed energy supplies as a response to sanctions. As yet, there are no indications that the war is likely to end soon, and we believe that markets have mostly adapted to the possibility that the war could drag on for some time. Any potential peace agreement, or even just an uneasy stalemate, would likely be welcomed by markets, particularly in Europe. Even if hostilities cease, we do not expect Russian sanctions to be eased for a long time.
Globally, relentless strength in the U.S. dollar has led other central banks to increase rates in order to defend their currency and battle global inflation. The Bank of England, the European Central Bank, the Swiss National Bank, as well as almost all emerging markets countries have raised interest rates in concert with the Fed. Japan continues to be the last major central bank that has not moved away from accommodative monetary policy. That said, the Japanese central bank intervened to support the Yen after it touched forty-year lows in September.
As interest rates rise and the world contends with the new geopolitical world order, global growth is slowing. As of September 2022, the OECD forecast U.S. GDP to be +1.5% for 2022, a sharp revision downward from its +2.5% forecast in June. The projected 2023 global GDP forecast was also revised downwards, to +2.2% from +2.8% previously. As we approach the Q3’22 earnings season, we have seen an increasing pace of earnings revisions along with some outright misses. In housing, existing home sales declined for the 8th straight month, down 26% through August. Overall, there are pockets of the U.S. economy clearly experiencing a slowdown, such as interest-rate sensitive sectors like housing, while, on the other hand, employment trends remain strong.
Looking to China, growth for Q3’22 is expected to rebound to 3.4% from 0.4% in Q2’22. We note, however, that this pace of GDP growth is well below China’s long-term average, as China’s zero COVID policy continues to hamper economic recovery. China’s real estate markets remain weak, and there is no indication that the government plans to relax its hardline virus policy despite moving to the endemic phase globally.
As we enter the final quarter of the year, we recognize that year-to-date returns have been disappointing. Macroeconomic conditions remain fragile, with a recession in the U.S. looking increasingly likely. While the September unemployment rate remained benign at 3.5%, the Fed’s own projections call for this number to rise to 4.4% by 2023. Using a metric known as the Sahm rule, a recession is all but inevitable when the unemployment rate rises by at least 0.5% from its low. In our view, a leveling off in the pace of rate hikes is necessary for sustained stability in both fixed and equity markets. While we have not yet seen the Fed ratchet down its hawkish rhetoric, we believe that we are much closer to the end of Fed rate hikes than the beginning. Once interest rates stabilize, even at their new higher equilibrium level, we believe that markets will be better able to forecast forward earnings and valuations across all asset classes.
While there is no perfect entry point for markets, we are more constructive than we have been in some time. We have all heard of the risk of “Black Swan” events that represent previously unknown risks. After the tough market environment year-to-date, we are now on the hunt for so-called “White Swans” -positive events such as an easing in core inflation, a de-escalation of hostilities in Ukraine, or a slower pace of Fed hikes, that would help markets price in more optimistic future scenarios. We acknowledge that there remain material downside risks, with a U.S. recession being the most prominent. There’s a saying that “trees don’t grow to the sky”— which means that nothing goes up forever. Right now, we would turn that around to note that “trees don’t shrink into the ground” and given the negative returns year-to-date, we think markets may be able to sprout new growth soon.
Notes: Asset class performance is in USD and refers to the following indices: Equities: US Large Caps (S&P 500), Emerging Markets (MSCI EM), Europe (MSCI Europe), Japan (MSCI Japan). Fixed Income: 10-Yr. US Treasuries (BofAML US Treasury Current 10-Yr.), Emerging Markets Sovereign (USD) (JPM EMBI Global), Emerging Markets Sovereign (LCL) (JPM GBI EM Global Diversified), US High Yield (BofAML US HY Master II), US Investment Grade (BarCap US Aggregate Bond), and Developed Markets Sovereign (excl. US) (JPM GBI Global Ex US). Source: Morningstar. (1) Strategy returns net of mutual fund expenses and Amerant Investments standard management fees.
You can see the returns for the first three quarters of this year on the left.
Q3’22 once again saw negative returns across all asset classes.
As mentioned in the “Markets Overview” section above, the backdrop of higher interest rates and slowing global growth caused equities to fall in the third quarter after a brief summer rally. The tech-heavy Nasdaq remains the worst-performing equity index in the U.S., down over 30% year-to-date. During Q3’22, US Large Caps also entered the bear market territory, down a significant 24% year-to-date as of the end of September.
Rates sold off again, with 10 Yr. US Treasuries were down 6.2% for the quarter (-16.8% YTD), which caused the US investment grade bonds to fall 14.6% YTD. While the year-to-date performance across asset classes continued its decline, the third quarter returns were less harmful than the second quarter, except for long Treasuries and emerging markets equities. With markets having already substantially repriced across multiple asset classes, we are optimistic that prospective returns can stabilize once the Fed slows its tightening campaign. We have already seen some indications of tightening financial conditions and a slower pace of hiring, but inflation remains stubbornly high. Still, we expect the rapid pace of rate hikes is nearly over, as the Fed’s latest “dot plot” shows the Fed funds rate peaking next year.
(1) Strategy returns based on the total return of the underlying mutual funds, including reinvestment of dividends and change in NAV. Net of mutual fund expenses and Amerant Investments standard management fees. Returns may vary. Past returns are no indication of future performance..
(2) Monthly returns before February 2010 are those of the offshore corresponding strategies. For the Dynamic portfolio, monthly returns before November 2009 are those of the Income & Growth portfolio, which is the neutral positioning of the Dynamic portfolio. Dynamic portfolio started in November 2009..
During Q3’22, all Portfolios posted negative returns (1), although not as negative as in Q2’22.
The Income Portfolio returned -5.5% (-18.6% YTD), the Income & Growth Portfolio returned -6.8% (-23.2% YTD), the Growth Portfolio returned -7.5% (-26.9% YTD), and the Dynamic Portfolio, positioned in the Income & Growth Portfolio, returned -6.8% during the quarter (-23.3% YTD).
As mentioned previously, there were few places to hide this year as markets have contended with four significant headwinds: High and persistent inflation (exacerbated by the Russian invasion of Ukraine), tightening monetary policy, rising interest rates, and slowing economic growth. After a brief summer rally, markets resumed their declines in September, leading to three straight quarterly losses.
You might have also seen purchase and sale activity taking place in early October. We have made these changes to better position the portfolios for the environment we described in the Market Overview above.
During early October, we increased duration in the US investment grade portion of the Income and Income and Growth portfolios. At that time, the UST10 was close to 3.3%, an attractive level for adding high-quality duration and protection to the portfolios. As mentioned previously, we are starting to see more value in US Investment Grade Bonds, and believe that going forward they will provide diversification benefits to help reduce equity and overall portfolio risk.
We have positioned portfolios more defensively to be better prepared to withstand an environment of increased volatility due to continued fears of recession and geopolitical risk, and to take advantage of what, in our view, will be continued dollar strength in the near term.
As always, we take the trust you have placed in us very seriously. In our day-to-day operations, we continue to follow current events and the reactions of the markets closely, and we stand ready to adjust your portfolios accordingly.
To obtain more detailed information on our market views or the performance of your advisory portfolio, please contact your investment consultant at Amerant Investments by calling (305) 460-8599.
Amerant Investments, Inc.
The model portfolios offered by Amerant Investments and described herein invest solely in mutual funds. Before investing, you must consider carefully the investment objectives, risks, charges, and expenses of the underlying funds of your selected portfolio. Please contact Amerant Investments to request the prospectus of the funds containing this and other important information. Please read the prospectus carefully before investing. Past performance is no guarantee of future returns. The value of the investments varies, and therefore, the amount received at the time of sale might be higher or lower than what was originally invested. Actual returns might be better or worse than the ones shown in this informative material.
This release is for informational purposes only. Past performance is no guarantee of future results. While the information contained above is believed to be from reliable sources, no claim as to their accuracy is made. Amerant Investments, Inc. provides no advice nor recommendation, or endorsement with respect to any company or securities. Nothing herein shall be deemed to constitute an offer to sell or a solicitation of an offer to buy securities. Member FINRA/SIPC, Registered Investment Adviser. Amerant Investments does not provide legal or tax advice. Consult with your lawyer or tax adviser regarding your particular situation.
Not FDIC Insured | Not Bank Guaranteed | May Lose Value | Not Insured By Governmental Agencies | Member FINRA/SIPC, Registered Investment Advisor
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