November 2022
US Economy: Is there a recession under the hood?
The US economy returned to growth based on the first release of Q3 GDP which surpassed expectations at a 2.6% annual rate. However, a look under the hood shows most of that was driven by exports and inventories while the contribution of consumption weakened. Also, stubbornly high inflation (8.2%YoY CPI in Sept.) with a backdrop of falling corporate earnings forecasts, and already weaker real estate, manufacturing and labor market data, all point to a rockier road ahead.
US Stocks: Halloween rebound.
On the heels of one of the more difficult months in recent memory, US equities posted their second strongest month of 2022 with a late October rally. Hopes the Fed would slow its pace of interest rate hikes, stocks appearing oversold based on technical indicators and relative resiliency in economic data were at the root. Energy (+69% YTD) was far and away the strongest sector with rising oil and gasoline prices driving a 25% return.
Foreign Stocks: A tale of two markets.
Non-US equity performance was bifurcated between advanced and emerging economies with the former less impacted by idiosyncratic issues. The US dollar wasn’t as much of a headwind, as a weaker yen continues to plague Japan and renewed Covid shutdowns in China and uncertainty around the presidential election in Brazil prevented more positive returns for both asset classes.
Fixed Income: High yield bonds follow equities upward.
The yield of the 10-year US Treasury has risen nearly 2.5% in the last year and settled near 4.1% in October, meaning core fixed income positions such as mortgages and municipal bonds have struggled. With a recession looming it may be surprising that high yield bonds outperformed but their relatively short duration limited the effects of interest rate increases and investors expect corporate defaults to be low, especially in energy which is a large component of the high yield market.
Real Assets: Public vs private real estate.
Real assets in October generally benefited from the incremental improvement in economic sentiment. Year-to-date performance is disparate across market segments: public REITs have fallen nearly 26% whereas many private real estate investments have posted gains. Private structures may have different mandates, use less leverage and face less liquidation pressure, but with other “risk assets” broadly in the red, it would be fair to expect some cooling in the private markets.
Alternatives: Non-traditional investments still diversifying.
Semi-liquid alternatives such as hedge funds didn’t do much better than tread water in October but have been modestly accretive to portfolios this year. Still, with public markets dislocated in varying degrees persistently above average volatility, the opportunity set for both semi-liquid and illiquid alternatives makes for a compelling time to establish long-term strategic positions.
Equities Total Return
| OCT | YTD | 1 YR | |
|---|---|---|---|
| U.S. Large Cap | 8.1% | (17.7%) | (14.6%) |
| U.S. Small Cap | 11.0% | (16.9%) | (18.6%) |
| U.S. Growth | 6.1% | (26.4%) | (24.7%) |
| U.S. Value | 10.4% | (9.5%) | (7.3%) |
| Int’l Developed | 5.4% | (23.2%) | (23.0%) |
| Emerging Markets | (3.1%) | (29.4%) | (31.0%) |
Fixed Income Total Return
| OCT | YTD | 1 YR | |
|---|---|---|---|
| Taxable | |||
| U.S. Agg. Bond | (1.3%) | (15.7%) | (15.7%) |
| TIPS | 1.2% | (12.5%) | (11.5%) |
| U.S. High Yield | 2.8% | (12.2%) | (11.4%) |
| Int’l Developed | 0.0% | (27.0%) | (27.9%) |
| Emerging Markets | (1.6%) | (14.7%) | (14.0%) |
| Tax-Exempt | |||
| Intermediate Munis | (0.2%) | (8.4%) | (8.1%) |
| Munis Broad Mkt | (0.9%) | (13.3%) | (12.5%) |
Non-Traditional Assets Total Return
| OCT | YTD | 1 YR | |
|---|---|---|---|
| Commodities | 2.0% | 15.8% | 11.2% |
| REITs | 3.9% | (25.8%) | (21.6%) |
| Infrastructure | 5.0% | (5.6%) | (4.7%) |
| Hedge Funds | |||
| Absolute Return | 0.0% | 1.1% | 1.2% |
| Overall HF Market | 0.0% | (4.5%) | (5.3%) |
| Managed Futures | 0.2% | 26.4% | 22.1% |
Economic Indicators
| OCT-22 | APR-22 | OCT-21 | |
|---|---|---|---|
| Equity Volatility | 25.9 | 33.4 | 16.3 |
| Implied Inflation | 2.5% | 2.9% | 2.6% |
| Gold Spot $/OZ | $1634 | $1897 | $1783 |
| Oil ($/BBL) | $95 | $109 | $84 |
| U.S. Dollar Index | 127.4 | 116.4 | 113.5 |
Our Take
All eyes have remained on the Federal Reserve through early November with sentiment regarding its approach to tightening market liquidity and monetary policy arguably still the most important factor in markets. Every economic data point is considered through the lens of what it will mean for Fed policy after more than one member of the FOMC has offered up that the Fed was willing to inflict some measure of “pain” on the economy in order to rein in inflation. That isn’t to say that the Fed wants to push the economy into a deep recession. In fact, over the last few weeks, pundits and Fed watchers had started to see an even chance that the latest economic data would give the Fed a reason to slow down the Fed funds rate hikes. That said, after another 0.75% rate increase in November, the committee might seem to be following through on their promise of pain. However, sometimes the accompanying statement to a rate decision is more telling than the magnitude of the move itself: In that statement, Fed Chair Jerome Powell offered mixed messages that suggested both a future reassessment but that there is “still a ways to go.”
Slightly less discussed is that Fed policy has been a key factor in the recent strength of the US dollar which has had a meaningful impact on both financial markets and the global economy. If the Fed keeps their head down with this quicker pace than other developed economies, the dollar will continue to look relatively more attractive. With net exports being the driver of Q3 US GDP growth, a stronger US dollar would be another headwind to consider in quarters ahead. Additionally, it would continue to detract from results from foreign investments for US investors. There are other factors that could boost the dollar, including if some other form of market or economic uncertainty strikes us, such as a resumed trade war with China or further escalation in the Ukraine/Russia conflict. Still, if history is a guide, the dollar is on par with peaks we haven’t seen in 20 years, and those proved to be short lived.
With the market volatility we have experienced, it is understandable to feel like dramatic changes need to be made in portfolios. Resisting that temptation can be an important part of achieving your long-term objectives as big “down days” in volatile periods are often followed by big “up days” and missing even the ten best days over a long time horizon can have a material effect on your compounded wealth. That doesn’t mean we are sitting on our hands. As we’ve mentioned in the past, we are tax loss harvesting, rebalancing and making manager adjustments within asset classes to consolidate our best ideas. Our managers have been re-underwriting their portfolios for an extended inflationary period and taking advantage of investing into yields and valuations we haven’t seen for quite some time. Lastly, at the portfolio level, we are also evaluating new opportunities in credit, supply chain related investments and activating strategic cash positions to lock in higher yields where possible.
