Monthly Market Commentary
Two Sides of the Same Coin: What Happens Next
Philip Blancato, Chief Market Strategist, Advisor Group
The first half of 2022 saw the S&P 500 post its worst return through June in more than fifty years and the Bloomberg U.S. Aggregate bond index record its largest quarterly loss since 1980 before tumbling further into what the New York Fed described as one of the fastest, deepest, and longest bond selloffs in four decades. Needless to say, it has been a difficult environment for investors this year. However, the S&P 500 has found some degree of support at the 20% down level as valuations have reset dramatically along with interest rate expectations. Fixed income finally appears somewhat attractive at higher rates, and corporate balance sheets as well as credit fundamentals remain quite strong. However, yields are expected to rise further this year, and should the economic slowdown turn more sever or inflation not abate as expected, bonds will continue to struggle. At this precarious point, the prudent investor raises a natural question: where do markets go from here?
Best Case Scenario: Soft Landing:
We begin with the optimistic scenario that the Fed competently navigates conflicting headwinds and adequately guides the economy to a soft landing. In raising interest rates and reversing more than a decade of easy money policy through quantitative tightening (QT), the Fed hopes to slow aggregate demand, subsequently forcing companies to tighten their belts and reduce hiring. Under the ideal conditions necessary to achieve a soft landing, this forces the significant jobs-workers gap to moderate, eventually establishes equilibrium in the labor market, and removes a major source of inflationary pressure. Assuming all goes to plan, inflation ultimately falls to more reasonable levels by the end of the year consistent with market expectations and the economy can grow at a rate closer to the historical trend rate of growth.
What does this mean for risk assets? Demonstrable progress towards a normalized inflation environment against the backdrop of slowing economic growth would likely lead the Fed to discontinue rate hikes and reexamine their QT program. The infamous “Fed Put”, or a capitulation in policy tightening in response to financial market volatility or distress, is exactly the catalyst both equity and fixed income markets could use to spark a turnaround. With the Fed on pause and a recession avoided, equities in particular would be primed for a major rally, especially considering American consumers, supported by some of the strongest household balance sheets and lowest levels of debt seen in years, have lived up to their reputation and shown admirable strength in continuing to spend despite higher prices.1 Assuming this “no recession” outcome comes to fruition, Goldman Sachs forecasts the S&P 500 finishes the year at 4300, roughly 14% above Q2 close.2
Worst Case Scenario: Recession:
Once again, the scenario hinges on inflation, the Fed, and its response to new market data. Another potential downturn would be driven by a correction in companies’ earnings. In preparation for/during a recession, market participants should limit exposure to cyclical assets, invest in longterm, secular trends, and capitalize on growth when growth is scarce. Lower quality credits tend to perform very poorly in broad economic downturns as the business cycle slows. Goldman Sachs’ worst case scenario projects a further leg down from current S&P 500 levels with a median decline of -17.5%, ultimately closing out the year at 3150.2 Although that outcome does sound frightening, going to cash is essentially never the prudent investment decision. Timing the market is extremely difficult, and it has been proven empirically that staying invested for the long term is a far more sensible strategy.
Base Case Scenario:
In this issue we have looked at essentially two polar opposite sides of the story. However, reality often does not play out in the extreme and it tends to leek more into a gray area. Thus, this gray area coincides with our team’s base case for what could occur. As previously mentioned, it will be challenging for the Fed to pull off a perfect soft landing, but at the same time we do not see a major downturn in the economy. As a result, we believe a mild, shallow recession may occur. The most penetrating effects of a recession are felt by the labor market, where millions of people may lose their jobs. However, we do not see this occurring as savings rates remain elevated and demand for workers remains strong. 3 Therefore, a downturn should not have a major impact on main street, making any sort of recession milder and shallower than previous downturns. Yes, there will probably be some re-pricing in equity markets, but we believe the majority of the pain has already been felt. We acknowledge that we are experiencing a Fed driven slowdown in attempts to reign in inflationary pressures, however, it seems that fears surrounding further rate hikes may be priced into the market and therefore any reversal in negative rhetoric by the Fed should help markets regain solid footing.
Unemployment Rate: The unemployment rate tracks the number of unemployed persons as a percentage of the labor force (the total number of employed plus unemployed). These figures generally come from a household labor force survey.
CPI (headline and core): Consumer prices (CPI) are a measure of prices paid by consumers for a market basket of consumer goods and services. The yearly (or monthly) growth rates represent the inflation rate.
S&P 500: The S&P 500® is widely regarded as the best single gauge of large-cap U.S. equities and serves as the foundation for a wide range of investment products. The index includes 500 leading companies and captures approximately 80% coverage of available market capitalization.
NASDAQ: The NASDAQ Composite Index is a broad-based capitalization-weighted index of stocks in all three NASDAQ tiers: Global Select, Global Market and Capital Market. The index was developed with a base level of 100 as of February 5, 1971.
Bloomberg Barclays US Agg Bond: The Bloomberg Barclays US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, MBS (agency fixed-rate passthroughs), ABS and CMBS (agency and non-agency).
Index performance does not reflect the deduction of any fees and expenses, and if deducted, performance would be reduced. Indexes are unmanaged and investors are not able to invest directly into any index. Past performance cannot guarantee future results.
The statements provided herein are based solely on the opinions of the Advisor Group Research Team and are being provided for general information purposes only. Neither the information nor any opinion expressed constitutes an offer or a solicitation to buy or sell any securities or other financial instruments. Any opinions provided herein should not be relied upon for investment decisions and may differ from those of other departments or divisions of Advisor Group or its affiliates. Certain information may be based on information received from sources the Advisor Group Research Team considers reliable; however, the accuracy and completeness of such information cannot be guaranteed. Certain statements contained herein may constitute “projections,” “forecasts” and other “forward-looking statements” which do not reflect actual results and are based primarily upon applying retroactively a hypothetical set of assumptions to certain historical financial information. Any opinions, projections, forecasts and forward-looking statements presented herein reflect the judgment of the Advisor Group Research Team only as of the date of this document and are subject to change without notice. Advisor Group has no obligation to provide updates or changes to these opinions, projections, forecasts and forward-looking statements. Advisor Group is not soliciting or recommending any action based on any information in this document. Securities and investment advisory services are offered through the firms: FSC Securities Corporation, Royal Alliance Associates, Inc., SagePoint Financial, Inc., Triad Advisors, LLC, and Woodbury Financial Services, Inc., broker-dealers, registered investment advisers, and members of FINRA and SIPC. Securities are offered through Securities America, Inc. and Ladenburg Thalmann & Co., broker-dealers and members of FINRA and SIPC. Advisory services are offered through Arbor Point Advisors, LLC, Ladenburg Thalmann Asset Management, Inc., Securities America Advisors, Inc., and Triad Hybrid Solutions, LLC, registered investment advisers. Advisory programs offered by FSC Securities Corporation, Royal Alliance Associates, Inc., SagePoint Financial, Inc., and Woodbury Financial Services, Inc., are sponsored by VISION2020 Wealth Management Corp., an affiliated registered investment adviser. Advisor Group, Inc. is an affiliate of these firms. 4879135
1 Bloomberg as of 7/15/2022
2Goldman Sachs’ Investment Research