Investors fear that rising interest rates will further depress stock prices
Investors have lost more than $7.6 trillion on U.S. stocks this year, and experts warn losses could increase by 2023.
From institutional investors to retail traders, it’s been a tough year to navigate the worst-performing market in five decades, says Bespoke Investment Group.
“It’s no secret that 2022 hasn’t exactly been the year of the 60/40 portfolio,” the group wrote in a research note in August, referring to a portfolio made up of 60% stocks and 40% bonds. “This year has left nothing certain with stocks and bonds hit hard.”
The Nasdaq is parked in what Wall Street calls a bear market — when prices fall 20% or more — while the tech-focused index is down nearly 30% year-to-date. The S&P 500 also fell into a bear market, slipping about 22% on the year. On Sept. 26, the Dow Jones Industrial Average, down 1.1%, became the last of the major U.S. stock indexes to fall into bear territory.
By comparison, when President Joe Biden took office in January 2021, markets had rebounded considerably from their lows in March 2020, when COVID-19 was declared a pandemic. The Dow was up about 61%, the S&P 500 was up about 67%, and the Nasdaq was up nearly 97% during that time. These indices then peaked at the end of 2021.
As the third quarter draws to a close, the Dow Jones is poised to lose 7%, while the S&P 500 and Nasdaq are each on track for more than 6% declines.
What drives the markets?
The three main drivers of this bearish market were soaring inflation, the Federal Reserve’s aggressive monetary policy tightening and growing concern about the global recession.
Despite the summer rebound, market analysts say the market rebound is over.
“There’s no reason this (stock) market shouldn’t go down a lot more,” Richard Weiss, chief investment officer for multi-asset strategies at American Century Investments, told Morningstar. “If history is any guide, the market could easily drop another 10-20%.”
Ray Dalio, the billionaire founder of Bridgewater Associates, reiterated that stance, suggesting that higher rates could drive stock prices further down.
“I estimate that a rise in rates from where they are around 4.5% will produce a negative impact of around 20% on equity prices (on average, although greater for longer term assets). duration and less for those with shorter duration) based on the present value discount effect and a negative impact of approximately 10% of the revenue decline,” he said in a LinkedIn post on September 13.
The Fed raised interest rates by 75 basis points at the September Federal Open Market Committee (FOMC) policy meeting, bringing the benchmark federal funds rate to a target range of 3% to 3.25% . According to a summary of economic projections by members of the rate-setting committee (pdf), interest rates could rise to 4.4% by the end of this year, then to 4.6% in 2023, before down to 3.9% in 2024 and 2.9% in 2025.
The central bank was expected to pull the trigger on a full point hike following a hotter-than-expected August inflation report. For now, Mimi Duff, managing director of GenTrust, notes that investors are pricing in a peak federal funds rate of 4.6% around May 2023 as they assimilate the Fed’s ‘higher for longer’ message. which fights inflation.
Instead of ultra-hawkish rate hikes, the Fed is “trying to look as tough as possible,” Christian Hoffman, portfolio manager and managing director of Thornburg Investment Management, wrote in a note.
“I would not be surprised to see Chairman Powell walk into the next meeting wearing a leather jacket and sporting a tattoo on his neck,” he wrote. “The Fed is poised to continue to hike through 2023 even if it means weaker growth and rising unemployment.”
Actions in the 4th quarter
What does this mean for stocks in the final months of 2022? Everything will depend on the data.
The FOMC’s economic projections show officials believe the unemployment rate will hit 4.4% next year and gross domestic product (GDP) will continue at an anemic 1.2% in 2023.
After two consecutive quarters of negative GDP growth rates, indicating a technical recession, the US economy is at risk of registering another quarter of GDP below zero.
The Federal Reserve Bank of Atlanta’s GDPNow estimate was cut to 0.3% on September 20 from an expected high of 2.6% on September 1. Investors are keeping a close eye on the GDPNow model, which predicts GDP growth.
Investors will pay attention to the final second-quarter GDP reading, the latest initial jobless claims, and August income and personal spending data, according to Deutsche Bank economists. They will be released later this week.
“In summary, Fed officials and market participants will get plenty of data to inform their views on the economic outlook. However, given recent Fed rhetoric, much of it is likely to play second fiddle to inflation data,” the financial institution explained in a note. “Continued upside inflation surprises could lead to a spike in the federal funds rate above 5%, particularly if it occurs in conjunction with easier financial conditions and a still tight labor market.
“Conversely, a faster decline in inflation, coupled with tighter financial conditions and some easing in the labor market, could lead to a terminal rate closer to 4%. At this point, we see biased risks in warmongering leadership.
The Fed and financial markets will both be in “information-gathering mode at this point,” Duff noted.
“[The] The Fed needs lower inflation and a labor market closer to equilibrium,” Duff said. “Lots of wood to cut on both fronts, so we have to see how the real economy evolves.”
Looking ahead to the home stretch of 2022, stock market forecasts are mixed. Morgan Stanley’s Michael J. Wilson predicts that “the bottoms of this bear market will likely come in the fourth quarter.” The S&P 500 could fall another 13% to around 3,400 in the final three months of 2022, he told Bloomberg in an interview.
A Reuters poll of strategists in August found the S&P 500 would end the year at 4,280. That would mean the broad measure of stocks is expected to rise about 16% in the final quarter.
Goldman Sachs cut its new 2022 year-end S&P 500 target to 3,600 from 4,300, citing rising interest rates.
Ultimately, “the fairy tale of the soft landing” – lowering inflation without causing economic pain – “is rapidly evaporating on Wall Street,” said Scott Anderson, chief economist at Bank of the West, in a note.
“As you can imagine, global stock markets aren’t swallowing the Fed’s message well, and stock analysts on the street are furiously slashing their year-end price targets. So now is a good time to keep our heads down and take cover as the Fed is about to start breaking our best china.