Another Rough Quarter
Investors continued to be buffeted by stormy markets in the third quarter with equities and bonds deteriorating further from their second quarter declines. Concerns over the ongoing strength of inflation and the prospect of recession created immovable obstacles for investors across multiple fronts. The U.S. equity markets fared better than those outside the U.S. with the Russell 3000 Index returning -4.5% for the period versus a return of – 9.9% for the MSCI ACWI ex U.S. index of foreign equities.
Bonds, in continuing an uncharacteristic performance, experienced a decline very similar to that of U.S. equities. We denote the rarity of the decline in bonds because year-to-date, their return of -14.8% as measured by the ICE BofA Corporate, Government and Mortgage Index, has been well beyond the decline for any previous calendar year. In fact, the worst annual return for the ICE Index is -2.8% in 1994. One key aspect of bonds’ weak showing year-to-date is that the increase in yields experienced thus far started from an exceptionally low level with the 10-year U.S. Treasury yielding 1.5% level at the beginning of the year and rising to 3.8% at the end of the third quarter. Contrast this with 1994 where the 10-year started the year with a yield of 5.8% and finished at 7.8% – a significant increase, but the percentage change in yield was much lower than what we have experienced in 2022 given the higher starting point at the beginning of 1994.
Financial assets were not alone in their decline during the third quarter. Commodities declined as well with the Goldman Sachs Commodity Index declining 14.3%. Even oil, which had risen from $75.33 per barrel to $107.76 per barrel over the first six months of the year, saw its price decline to $79.91 per barrel at the end of the third quarter.
Not all numbers associated with the third quarter are negative. The current estimate of U.S. GDP growth for the period is forecast to come in at 1.4%. This follows the negative results for the first two quarters of 2022.
Fourth Quarter Outlook
In addition to the positive GDP growth expected to be reported for the third quarter the consensus view for the fourth is for another positive result albeit a more modest one at 0.9%. Recession is not expected in the near term, as indicated by the expectation of positive growth for the remainder of the year. As we have discussed in previous communications the labor market in the U.S. continues to be robust. The unemployment rate currently sits at 3.5%, initial claims for employment have been trending lower and the JOLTS measure of job openings most recently registered 10.05 million. In fairness, the JOLTS measure has declined to the current level from a high of almost 12 million earlier this year, but it is still over two million openings higher than the results seen in the years leading up to the pandemic. Also, Gross Domestic Income (GDI) was positive for the first two quarters despite the decline seen in GDP. For clarification, the GDI measures what all participants in the economy make, or “take in.” These include wages, profits, and taxes. Alternatively, GDP totals the value of the goods and services the economy produces. And finally, consumer confidence has recovered from the lows seen a few months ago. Numerically this is illustrated by the University of Michigan’s Consumer Sentiment Index which hit an all-time low level of 50.0 in June but has since rebounded to the most recent reading of 58.6.
Coincidental to these statistical measures supporting the thesis that a recession is not imminent is the growing probability that a recession will occur. Numerous prognosticators are forecasting that a recession will develop some time next year. A key driver to the outlook for a recession coming to fruition is the often stated resolve being communicated by the Federal Reserve (Fed) to bring the rate of inflation down to their targeted level. The Fed has already raised its federal funds rate five times this year with the expectation that at their next meeting in November another 75 basis point fed funds increase will be implemented. As the Fed continues to raise interest rates there is a concern they may be overly aggressive in their efforts and a byproduct will be an economy pushed into recession. As we move into the fourth quarter and beyond, we will be monitoring developments on the inflation front as well as the actions and commentary from the Fed to determine if they necessitate any changes to our asset allocation positioning or significant shifts within our proprietary investment strategies.
Asset Allocation Overview
We are maintaining our current asset allocation positioning. This positioning has all major asset classes held at their neutral positions relative to their allocations in our strategic benchmark. With the declines in value that occurred in financial markets during the quarter, the returns for each of our five investment objectives were also negative.
The rationale for maintaining this positioning is based on our outlook for the fixed income and equity markets. With the increase in yields and the anticipation that inflation has likely reached its peak, a level of stability should present itself in the fixed income markets keeping yields in a trading range. On the equity side, we have seen a significant recalibration of valuations, particularly in higher growth sectors such as information technology. This reduction of valuations combined with negative sentiment and the fact that earnings are anticipated to continue growing helps to limit downside, not to mention the meaningful decline equities have already experienced year-to-date.
While no one enjoys seeing market values decline be it fixed income or equities one positive step investors can take in response to these episodes is to review their investment objective. Evaluating how extensively their portfolio has participated in the adverse market environment thus far in 2022 can help investors determine whether their current investment objective truly reflects their goals and risk tolerance.
Source: BTC Capital Management, Ibbotson Associates, FactSet, Refinitiv.
The information provided has been obtained from sources deemed reliable, but BTC Capital Management and its affiliates cannot guarantee accuracy. Past performance is not a guarantee of future returns. Performance over periods exceeding 12 months has been annualized.
This content is provided for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Statements in this report are based on the views of BTC Capital Management and on information available at the time this report was prepared. Rates are subject to change based on market and/or other conditions without notice. This commentary contains no investment recommendations and should not be interpreted as investment, tax, legal, and/or financial planning advice. All investments involve risk, including the possible loss of principal. Investments are not FDIC insured and may lose value.