WESCAP Q3 Quarterly Commentary: Rising Interest Rates & Recession Fears
The U.S. Federal Reserve increased the Fed Funds rate by 0.75% in September, bringing the total rate increases in 2022 to 3%. Over the next 6 months, 1.25% to 2% in additional rate hikes are expected; depending upon the path of future inflation.
As mentioned in our prior quarterly letter, such interest rate increases have been a good predictor of a recession, as has the recent inversion of the U.S. Treasury yield curve.
Global stock markets are already priced for a mild-to-moderate recession. The S&P 500 lost 23.9% for the first 9 months of 2022. Small cap stocks and global stock indices lost more than 25% over the same time span. These magnitudes of declines typically occur about 6 months before a recession. After a recession is actually underway, but before a trough is reached, stock markets typically begin to rise in anticipation of recovery.
It is not clear if we are facing an imminent recession and the stock market could be giving us a false signal, at least in the short-run. Unemployment is still very low and more jobs are available than there are people to fill them, though very recent data suggest the beginning of a reversal in what has been an extremely tight labor market. Until the unemployment rate shows a large increase, it is hard to make a case for a recession.
So why the big stock losses so far this year? Fear of a recession can also cause stocks to drop, even if a recession fails to materialize. Pervasive declarations of a 2022 recession by “experts” and media may have created enough recession anxiety to move up stock market declines from next year into this year. Stocks are priced now for a recession that may not occur for more than a year. It normally takes 21 to 28 months for higher interest rates to result in a recession, which would be in late 2023 or in 2024.
Various indicators show a lot of pessimism. However, these are contrarian indicators, which typically foreshadow strong stock market returns over the next 6 months to a year. Additionally, the last 18 mid-term elections had S&P 500 subsequent 12-month returns of 4% to 36%, with an average of 18.6% (Forbes). This, too, suggests positive returns, starting after early November.
The interest rate increases hurt long-term bonds as well. The U.S. 20+ Year Treasury Index has lost 30.1% year-to-date. Until the Federal Reserve pivots toward lower interest rates (probably in 2023-24), this and other longer term fixed-income assets continue to be high-risk. Our shift this year to somewhat less risky assets has helped. Patience, discipline and attention to fundamentals remain key to long-term success.
As always, please feel free to contact WESCAP at (818)563-5170 or contactus@wescapgroup.com if you would like to discuss any of this further.