This quarter, NASA’s DART program successfully redirected an asteroid setting the stage to protect the earth from rogue asteroids with the potential to cause Armageddon. Unlike DART, the FED has a dual mandate of full employment and price stability.
The Fed has made clear its intent to save its reputation and the economy from rogue inflation by redirecting it back to its 2% target, even if it causes recession and unemployment. The Fed is not conducting an experiment to be prepared for some future event, rather, they are affecting our lives today.
The determination to fight inflation has caused much anxiety and stress this quarter as we saw what the withdrawal of cheap money looks like. With the Fed continuing to raise rates and reiterating its intention to crush inflation, we witnessed a violent sell-off at the end of the quarter, driving the Russell 3000 down 4.5%, and bonds, the traditional safe-haven fell 5.6% as measured by the 7-10 Year Treasury Index for the quarter. While employment and consumer demand continue to hold up, a recession is increasingly likely.
At the end of last year, 10-year Treasuries yielded just 1.5%, and 10-year Treasury Inflation Protected Securities (TIPS) yielded a negative 1.1%. Inflation was 7.0%, but the Fed thought it was “transitory as it held its interest rate to just 0.25%. It took until mid-March for the Fed to finally begin to raise rates and acknowledge they needed to address inflation. CPI peaked in June at 9.1% but remains above 8.0%, and core inflation, excluding food and energy, rose to 6.3% in August, 0.4% higher than in July.
The Fed is not yet ahead of the inflation pressures in the economy. A tracker from the Fed’s Atlanta branch shows that in August, wages rose at an annualized pace of nearly 7%. To crush the budding price-wage spiral, the Federal Reserve has raised interest rates at the fastest trajectory since 1980. We expect the Fed to continue raising short-term rates until it has subdued inflation. While this may cause longer term yields to rise further in the short run, assuming the Fed does get control of inflation over the next year or two, the outlook for future long-term bond returns is better than it’s been in almost a decade.
So, the big question is, have stocks fallen far enough to become bargains? The short answer is no. Stock prices have fallen such that the S&P 500 is near fair value relative to earnings on various measures. Fair value is not the same as a bargain. Further, earnings are high relative to trend growth and can be expected to fall in the event of a recession.
So, we may have not hit bottom yet, but thinking in terms of waiting for a bottom and buying the bottom can be self-destructive by causing you to miss buying opportunities and keeping you out of stocks for the long run. We won’t know when the bottom is until it is past, but we know that stocks today offer better future long-term returns than they did just a quarter ago, and further declines create better future returns from here. The benefits of staying disciplined are significantly based on history. Per Dimensional Fund Advisors(1), following a 20% decline of the US equity broad market, the subsequent 3-year return was a cumulative 41.1%.
During periods of financial stress and equity market declines like today, it can be helpful to reassess your financial plan and make adjustments to keep you in the Comfort Zone. Our patented financial planning approach is designed to help you navigate difficult times with confidence. Please reach out to me if you would like to review your plans or have any other concerns.
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