I lived in Wichita, Kansas when I was first married. It took time to get used to the voluminous tornado warnings while living in the heart of “Tornado Alley”. Kansas gets about 100 tornadoes a year. Interestingly, the people of Wichita were quite lackadaisical about the sirens. Students at the college I was attending simply ignored them (perhaps not unusual behavior for “invincible” young adults). But I found the older adults working in my office building once I became a Financial Advisor also reacted similarly. “Should we move to the basement?” I’d ask when the siren went off. They chuckled a bit. One native Kansan co-worker of mine informed me he didn’t go to the basement until he saw large objects like patio furniture flying across the yard. I later learned that he once waited so long that he leapt down the stairs and landed on the basement floor just as the roof blew off his house.
Investing can feel a bit like living in Tornado Alley. At times there are warning sirens, and we fear turbulent markets are coming only to find it never comes or isn’t as bad as feared. Other times, a bad market can come without any warning.
We ended 2022 with “bad news fatigue” after experiencing month-after-month of negative headlines like the “voluminous tornado sirens” I endured in Kansas. Much to many people’s surprise, this year’s major markets were strong the first half of the year. The S&P 500 index increased almost 17% through June 30, and international stocks nearly 12%. Even bonds posted a positive 2% return. It’s not unusual for markets to “bounce back” after a particularly difficult year, but those “tornado sirens” left everyone feeling overly skeptical. Contrasting to last year, there are many reasons for this year’s positive market results:
We began seeing signs of elevated U.S. inflation in 2021 until it peaked in June 2022 with a 9.1% increase over the preceding 12-month period, the largest 12-month increase in 40 years 1.
According to the Bureau of labor statistics, inflation has been steadily dropping since its peak in June 20222. Still elevated from the Federal Reserve’s desired 2% target, inflation is trending in the right direction and sitting at roughly 3%.
The below chart shows the monthly year-over-year inflation which rapidly increased in 2021 through the first half of 2022 and just as rapidly decreased thereafter.
Interest Rate Hikes
The Federal Reserve mistakenly believed the inflation readings in 2021 were “transitory” (temporary). By March of 2022, they finally acknowledged inflation was a serious threat and took an immediate and aggressive stance to tame inflation with a series of rapid interest rate hikes. By the time it was done, there were seven successive rate hikes ranging from 0.25-0.75% in 2022, and four additional 0.25% rate hikes thus far in 2023. We started with near “zero” interest rates in March 2022 and ended with rates 5.25-5.5% by July 26, 20233.
- The chart below shows the recent rate hikes from March 2022 through July 2023.
FOMC Meeting Date
Rate Change (bps)
Federal Funds Rate
July 26, 2023
5.25% to 5.50%
May 3, 2023
5.00% to 5.25%
March 22, 2023
4.75% to 5.00%
Feb 1, 2023
4.50% to 4.75%
Dec 14, 2022
4.25% to 4.50%
Nov 2, 2022
3.75% to 4.00%
Sept 21, 2022
3.00% to 3.25%
July 27, 2022
2.25% to 2.50%
June 16, 2022
1.50% to 1.75%
May 5, 2022
0.75% to 1.00%
March 17, 2022
0.25% to 0.50%
The Fed is carefully watching inflation and economic data. We believe we are closer to the end of the rate hikes than the beginning, and the market has priced in similar sentiment. It is anticipated that rates will be lowered in 2024.
As if the poor market results of 2022 were not bad enough, investors faced headline news about an upcoming recession caused by the rapid increase in interest rates. It is widely known that the majority (although not all) of U.S. recessions have followed interest rate hikes4. The question was (and still is) whether the Fed can navigate a “soft landing” as it has sought to slow down the economy to fight inflation.
The U.S. economy has remained resilient thus far. The U.S. Bureau of Economic Analysis has reported positive real gross domestic product (GDP) through the end of 2022 and each quarter this year5. For reference, GDP growth between 2-3% is considered normal.
The labor market has also continued strong. The “mass layoffs” that usually come with a recession are not yet seen as we maintain record low unemployment.
Despite the good news, a storm appears to be brewing on the horizon. The Conference Board Leading Economic Index (LEI) is a predictive variable that anticipates turning points in the business cycle. It has been in decline for fifteen months – the longest streak of consecutive decreases since 2007-2008 during the runup to the Great Recession, according to Justyna Zabinska-La Monica, Senior Manager, Business Cycle Indicators, at The Conference Board6. Based on the data, the forecast is the U.S. economy is likely to be in recession later this year into early next year. According to The Motley Fool, this economic indicator stands head and shoulders above most other predictive economic tools and hasn’t been wrong in 64 years.7
In 2022, both the quantity and size of interest rate hikes were more than the market anticipated, resulting in the worst year ever in 2022 for bonds8. U.S. stocks fared better than they have in prior bear markets but still ended with a loss not far off from the U.S. bond market losses, the only time in history that both stocks and bonds had double-digit losses in the same year9.
Investors who kept bonds on the shorter side (as I had advised my clients to do) fared better since short-term bonds held up better during this period of rising interest rates than long-term bonds.
In 2023, the markets have thus far appropriately responded to the positive news on inflation, the continued strong economic growth, resilient labor market, and strong corporate earnings that have been beating expectations.
With the good news on the economy, corporate profits and inflation, we see the possibility for continued tailwinds to support the stock and bond markets.
The chart below shows the S&P 500 has almost fully regained its losses of 2022 and is within a short distance of reaching its all-time high value.
Source: J.P.Morgan Asset Management. Guide to the Markets as of July 31, 2023.
With the “tornado siren” beginning to sound about the economic outlook (which is likely to squeeze corporate profits going into 2024), we see this as a good time to reassess your portfolio. We advise investors to:
- Assess your risk tolerance and whether you have the right ratio of stocks to bonds. While equities have produced higher long-term returns than bonds historically, they do come with more volatility and risk. It’s a compelling time for fixed income now that yields are higher than we have seen in 10-15 years. With the possibility that the Fed is soon to pause rates, it appears to be a good point in the interest rate cycle to shift more into bonds if that better aligns to your risk level and goals.
- Consider the types of fixed income you’re invested in. We see this as an appropriate time to shift a portion of your fixed income into intermediate bonds to secure the current interest rates in light of the possibility that rates could be lower in 12-24 months.
- Take stock of your overall balance sheet. Consider trimming from stocks and using the proceeds to replenish any cash reserves that may be light. Currently, treasury money market funds are paying a rate of interest that is above inflation. That is not anticipated to last long as historically interest on cash tends to match inflation more closely. If you’re carrying any debt, consider the interest rate on that debt. If it’s higher than the projected return on your portfolio, it may make sense to pay it down.
Our objective is to help our clients select a portfolio strategy that keeps them comfortably invested through both good times and challenging times. We are always open to revisiting your portfolio strategy and desired risk to confirm the optimal mix of stocks, bonds, alternatives and cash for you. In the meantime, we will continue to monitor the market and economic conditions in light of our clients’ long-term investment objectives and will keep you apprised of any changes to our investment outlook.
Anne M. Ward, CFP®, MPAS©, AIF®, CRPC™
Founder & Principal Wealth Manager
1 U.S. Bureau of Labor Statistics (2022, July 18) Consumer prices up 9.1% over the year ended June 2022 – largest increase in 40 years. https://www.bls.gov/opub/ted/2022/consumer-prices-up-9-1-percent-over-the-year-ended-june-2022-largest-increase-in-40-years.htm
2 U.S. Bureau of Labor Statistics (2023, July 17). Consumer prices up 3.0% over the year ended June 2023. https://www.bls.gov/opub/ted/2023/consumer-prices-up-3-0-percent-over-the-year-ended-june-2023.htm
3 Tepper, T. (2023, July 26). Federal Funds Rate History 1990 to 2023. https://www.forbes.com/advisor/investing/fed-funds-rate-history/
4 The Investopedia Team. (2023, August 10). US Recessions Throughout History: Causes and Effects. https://www.investopedia.com/articles/economics/08/past-recessions.asp
6 The Conference Board (2023, July 20). US Leading Indicators. https://www.conference-board.org/topics/us-leading-indicators
7 Williams, S. (2023, June 27). This economic indicator hasn’t been wrong in 64 years - - is its flawless streak about to end? https://www.fool.com/investing/2023/06/27/this-economic-indicator-hasnt-been-wrong-64-years/#:~:text=This%20leading%20economic%20indicator%20hasn,most%20other%20predictive%20economic%20tools.
8 Rosen, A. (2023, February 9) The worst bond year ever was 2022 – what does that mean for you? https://www.forbes.com/sites/andrewrosen/2023/02/09/the-worst-bond-year-ever-was-2022--what-does-that-mean-for-you/?sh=3f013d743ae8
9 Duberstein, B. (2023, January 26). 2022 was the worst year since 1937 for this investing strategy: here’s what history says happens next. https://www.fool.com/investing/2023/01/26/2022-was-the-worst-year-since-1937-for-this-invest/
The views expressed within this newsletter are subject to change at any time without notice and are not intended to provide specific advice or recommendations for any individual or on any specific security or strategy. This commentary is provided for informational and educational purposes only. Information obtained from third party resources are believed to be reliable but not guaranteed. The information, analysis and opinions expressed herein reflect our judgment as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation. All investments carry a certain risk and there is no assurance that an investment will provide positive performance over any period of time. Information obtained from third party resources are believed to be reliable but not guaranteed. Past performance is not indicative of future results.