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Q3 Market Recap: Recession Rumbles

Executive Summary

With inflation and interest rates on the rise and a mid-term election around the corner, it is no surprise we’re facing a volatile time in the market. In fact, by the much-contested definition of “recession,” we are already in a mild one. (The general rule of thumb is that two negative quarters of GDP signifies a recession.) Still, we’ll likely have to wait until after election season to hear the official word.

Why? The National Bureau of Economic Research (NBER) is responsible for defining when a recession begins and ends. With the election coming up in November, the non-partisan NBER does not seem to want to get political and has stayed tight-lipped.

Whatever the decision is, if we are in a recession, it’s a mild one so far. But with inflation rising, market returns on a rollercoaster, and a stubbornly inverted yield curve sticking around, it’s anyone’s guess whether this will turn into a full-blown recession or not.

Theme 1: All eyes remain on inflation.

Inflation continues to be the market’s main focus, compelling the Fed to substantially increase interest rates. We have talked at length about the relationship between rising rates and inflation, so let us dive into a different chapter in the inflation story: the Strategic Petroleum Reserve (SPR).

The SPR is effectively the U.S. government’s backup oil reserve. It’s there to serve as a buffer in case of crisis, but it is also a powerful political tool. Both the Bush and now Biden administrations have leveraged the SPR to help bring oil prices down. To deal with the current crisis, the Biden administration has been releasing 1 million barrels per day. Demand and production are stable, but much of the recent declining prices were due to the extra oil coming out of the SPR. This is set to end shortly before the next election.

Our current petroleum reserve isn’t just low — it’s the lowest it’s been since the 1980s. In addition, OPEC+ (meaning OPEC with Russia) is slowing production, and our SPR reserves diminishing. We could see energy reassert itself as an inflation driver the next quarter, especially if we avoid a deeper recession.

If inflation creeps back in and stays elevated, it will be difficult for the Fed to make their perceived pivot and could increase the chance of a more-than-mild recession in 2023. To give a quick summary, more stock market volatility is the most likely outcome.

Theme 2: A rollercoaster of returns.

Once again, volatility described last quarter. Intra-quarter returns were up close to 15% through August. The market thought inflation had peaked and began a rally, but August’s high inflation reading stopped both investors and Fed officials in their tracks.

At the most recent Sept. 20 policy meeting, chairman Jerome Powell alluded to even more planned rate hikes before the end of the year. The result of this quick pivot was a drastic selloff of bonds and stocks. Although returns were up 15%, they ended the quarter at -5%, as you can see in the Morningstar graph below.

The next graph adds to the volatility story. As you can see, at the end of August — when the market was still up about 5% for the quarter — the expectation was that Fed fund rates would be at the level they’re at now at the end of the year. Instead, they’re now projected to be 50 basis points (or 0.5%) higher. The market had to price out 50 basis points of rate hikes over the course of one month while the market went down.

Theme 3: The inverted yield curve hasn’t budged.

Rising interest rates put pressure on equities and financial conditions. Between these rate hikes and inflation, it’s no surprise the yield curve has remained inverted.

Remember, the yield curve shows the relationship between long- and short-term interest rates. When it’s inverted, a consistent explanation of this phenomenon is investors are moving short-term bond money into long-term bonds. That implies investors may be viewing the market pessimistically. The inverted curve could also signify that demand for short-term cash is increasing as banks slow lending.

Inverted yield curves have predicted future recessions with 100% accuracy. So, once again, we may already be in a mild recession with politics and NBER possibly at play.

Looking Ahead

We are heading into what I call silly season, a.k.a. mid-term election season. We would not be surprised post-election to see the news come out officially that we’re in — and have been in — a recession. It also would not be surprising to see inflation level out after the election to around 6% — well above the Fed target.

Regarding trading ranges, the S&P is currently in the 3500 – 3900 range. Below 3500, we would buy aggressively and would likely fade above 3900. That puts us in a bit of a holding pattern until we see which direction to go. For now, we have raised some cash in portfolios, and certain equity strategies hold near 10% in short-term treasuries be redeployed if we see positive signals or used to buy back into the market if we see S&P numbers drop below 3500. If we break out above 3900 and our indicators turn positive, we would then add risk. The GWS Investment Committee considers all these scenarios when managing your money.

With all the forces impacting the market, it can be hard to sift through the noise, which is why our Investment Committee does it for you. The GWS Investment Committee remains committed to the following investment management goals for our clients:

  1. To pursue long-term returns that first and foremost strive to help clients work toward all goals in their financial plans.

  2. To seek excess return above each portfolio’s benchmark over a three-year trailing time period and a full market cycle, in order to hopefully cover client fees and add surplus to their portfolios.

  3. To implement investment strategies that align with each client’s personal volatility and benchmark sensitivity to help them remain confidently invested and long-term focused.

A lot could change as we head into election season, and we are committed to keeping you up to date on our Monthly Market Insights broadcasts at 3:30 p.m. CT via YouTube Live. Be sure to tune in! We are here to help you make sure you are doing the right things to preserve your wealth, which is part of our mission to help people become and remain financially self-reliant.


Securities and advisory services are offered through LPL Financial, a Registered Investment Advisor, Member FINRA/SIPC.

The opinions expressed are those of John Gatewood as of the date stated on this material and are subject to change. There is no guarantee that any forecasts made will come to pass. This material does not constitute investment advice and is not intended to endorse any specific investment or security.

Please remember that all investments carry some level of risk, including the potential loss of principal invested. Indexes and/or benchmarks are unmanaged and cannot be invested in directly. Returns represent past performance, are not a guarantee of future performance and are not indicative of any specific investment. Diversification and strategic asset allocation do not assure profit or protect against loss. With fixed income securities and bonds, when interest rates rise, bond prices usually fall because an investor may earn a higher yield with another bond. Moreover, the longer the maturity of a bond the greater the risk. When interest rates are at low levels, there is a risk that a significant rise in interest rates can occur in a short period of time and cause losses to the market value of any bonds that you own. At maturity, the issuer of the bond is obligated to return the principal (original investment) to the investor. High-yield bonds present greater credit risk than bonds of higher quality. Bond investors should carefully consider risks such as interest rate risk, credit risk, liquidity risk, securities lending risk, repurchase and reverse repurchase transaction risk.

Investors should be aware of the risks of investments in foreign securities, particularly investments in securities of companies in developing nations. These include the risks of currency fluctuation of political and economic instability and of less well-developed government supervision and regulation of business and industry practices, as well as differences in accounting standards.

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