Fall 2022 Market Perspective with Brett Carleton

In preparing to write this quarter's market perspectives, I went back over all the information we have sent out so far this year. The key points of discussion have been consistent throughout 2022; inflation, the Russian invasion of Ukraine, The Federal Reserve Bank (The Fed), supply chains, and market volatility. These are the main talking points as we enter the fourth quarter points. Stock and bond market volatility has been elevated all year as we have been saying based on historical precedent. This is the fourth period of “The Fed” raising interest rates (tightening money supply) since 2000, the most recent being 2017-2018 when U.S. equity markets were down 20% with the cycle culminating in the Christmas Eve massacre (put a real damper on the holiday celebrations).

We have had short bouts of inflation in recent decades, but nothing like what we are currently experiencing. The Fed at this time appears to be committed to bringing inflation down to more normal levels through the tightening of the monetary supply. They continue to raise interest rates, which makes money more expensive, at the same time they have begun to unwind the Quantitative Easing that we have heard so much about. This is the process of The Fed beginning to sell Treasury bonds purchased during the pandemic with money they created. This helps take money out of the economy as investors buy these bonds from The Fed, at which point the money is taken out of the system. On top of these actions, The Fed has limited the number of loans the biggest banks can make at this time and is paying banks to keep money at The Fed. Will all this be enough to slow inflation without throwing the U.S. economy into a recession?

One might ask, why is The Fed so focused on taming inflation? For those of us old enough to remember the ‘70s, inflation is a tax on everyone with the greatest negative impact on those with the lowest incomes. Once it sets into an economy, it’s a real challenge to overcome. The biggest factors that led to our current situation are supply chain disruptions due to Covid closures, The Fed stimulus (QE), and government stimulus. We have discussed The Fed’s reversal in policy, Washington has cut back significantly on stimulus, and global supply chains are slowly recovering as countries reopen and demand for goods begins to slow. If you recall, at the height of the Covid lockdowns, there was an almost four-fold increase in retail sales as we all shopped online, which has now slowed significantly to more normal levels. The backlog of container ships at the ports of LA and Long Beach has decreased significantly. Having said that, there are still supply chain constraints as China still grapples with its zero Covid policy (I will discuss in a later article how the world’s supply chains are evolving post-Covid).

The Russian invasion of Ukraine initially exacerbated an already bad global picture, especially in food, energy, and commodities. August marked 6 months since the initial invasion, and despite the continuing war, prices had dropped significantly in energy and other commodities. Housing has been another big factor in the inflation picture, and prices are now down for the first time in years (rents were even down in August). Housing prices spiked like so many other items during Covid as people adjusted to the lockdowns and wanted bigger homes. Lumber prices have dropped to pre-Covid levels as the home remodel craze has slowed. We're even beginning to see more workers slowly come back into the labor force. When we chose to shut down the global economy, no one had any idea of the consequences of this action, and I believe it will take a few years to complete this “normalization process”. We will work through this just like other economic challenges we have faced in the past. Each economic downturn is unique in its causation, but the process the economy goes through is very similar. We will recover from this and experience growth again. One must remember the reasons why we invest in the greatest companies in the world -- to participate in their growth over time.

Please share any thoughts or comments you may have with us. We always enjoy your input.

Brett S Carleton, CFP