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A Historic Year

After a rally in July, global stocks and bonds turned lower and registered negative returns for the last quarter. We are witnessing a powerful moment in modern market history. Following the rare feat of seeing both stock and bond prices fall two quarters in a row, we’ve now seen it happen for three. After an early July report showing inflation may have peaked, investors started to believe that the interest rate tightening may soon end. And then, in August, markets absorbed the one-two punch of higher-than-expected inflation followed by this very clear message from Chairman Jerome Powell:

“If the public expects that inflation will remain low and stable over time, then, absent major shocks, it likely will. Unfortunately, the same is true of expectations of high and volatile inflation. During the 1970s, as inflation climbed, the anticipation of high inflation became entrenched in the economic decision-making of households and businesses. The more inflation rose, the more people came to expect it to remain high, and they built that belief into wage and pricing decisions. As former Chairman Paul Volcker put it at the height of the Great Inflation in 1979, “Inflation feeds in part on itself, so part of the job of returning to a more stable and more productive economy must be to break the grip of inflationary expectations.”

With that, the summer bounce was over, and both stocks and bonds sold off almost daily through September. Stocks limped into October down nearly 25% on the year, and bonds, formerly known to be an effective hedge in moments like this, have been down double digits too.

As we take a long-term view, only in the 1930s was there a prolonged period of stocks and bonds falling sharply together. Since we all know stocks can have periods of significant weakness like this, it’s important to highlight just how unusually bad this year has been for traditional bond investors.

Q3 Review 

On a good note, markets have corrected many of the excesses of recent years, possibly setting the table for a period of more reliable returns ahead. We will look more at that later, but first, here are a few key fundamental debates taking place in markets now:

  • Unemployment remains low (3.5%), but leading economic indicators have fallen for six months in a row.
  • Headline inflation (gasoline) may have peaked, but the services components (shelter, wages) appear stickier.
  • Global growth is slowing, but analysts are still forecasting U.S. companies to grow. For all its warts, the U.S. Dollar has been a safe haven relative to other major currencies:

Portfolio Changes 

Our focus in Q3 was squarely on our growth allocations, which represents the U.S. and International Equity exposure we manage for our clients. In summary:

  • We added to a dividend focused ETF with proceeds from an active real estate fund and international ETF.
  • We added GQG Partners International Quality Dividend Income within our international stock portfolio. We are underweight to international developed and emerging markets relative to the global stock index.
  • We added an active ETF manager who focuses on businesses that benefit from persistent inflation.
  • We sold Nuveen ESG Small Cap Equity (NUSC) and replaced it with SPDR Small Cap Value (SLYV)

As a whole, these moves deliver the following portfolio benefits:

  • Reduced expenses
  • Higher yield
  • Increased exposure to small-cap value

Contributors and Detractors 

As we highlighted in the intro, it was a difficult quarter with virtually nowhere to hide; even Treasury Bills lost ground. In your portfolios, assets holding either high levels of cash or substantial exposure to our Defensive allocation faired markedly better than the Blended Benchmark. Schwab Short-Term U.S. Treasury Fund, the Merger Fund, Stone Ridge Diversified Alternatives, and options based ETFs from JPMorgan and Aptus all contributed to the relative outperformance.

At the other end were those banking on growth … Wisdom Tree Emerging Markets, Schroder International Stock, and Brown International Small Cap all had double-digit losses or close to it. Even gold failed to shine and is down nearly 10% in this inflationary environment. You’ll hear more about our treatment of gold in this environment as the strength of the U.S. Dollar has not been a good backdrop for gold investors.

Risks and Outlook 

War(s), inflation, midterm elections, real estate values, and fiscal policy will continue to dominate headlines.

Source: Strategas as of 09.30.2022

We’re not ready to position for a roaring bull market. But we know that, just as investors shouldn’t chase high prices when all news is good, they also shouldn’t cave in to low prices when news is bad.

And as we said last quarter, we also take comfort in the ingenuity of capitalism and the history of markets, which have ultimately rewarded long-term investors throughout a range of unique bear market environments:

Sentiment may tempt even the most patient and disciplined investor to sell low, but please consider:

  • Every single bear market in the history of U.S. stocks has eventually migrated to new all-time highs.
  • History shows buying stocks when there is fear in the streets is beneficial.
  • There is no guarantee that buying stocks when they are down will lead to better outcomes but expected returns should be higher when prices are lower.

As always, we remain grateful for your continued trust in all we do related to planning and investments.