* Ready, Fire, Aim: Fed Chair Powell Jackson Hole speech sends stocks sharply lower.
* Reading the Room: “Some pain to households and businesses”
* Active Management: Possible strategies and implementations to relieve pain
August 2022 Returns:
Approximately $2 trillion in global stock market capitalization was lost as Federal Reserve Chairman Jerome Powell spoke and said the word “inflation” 47 times in the span of his eight-minute speech.[ix]
Until his short presentation at the Jackson Hole Economic Symposium on August 25 sent stocks lower, U.S. equities spent most of the month of August adding on to July’s gains. By month’s end, however, U.S. equities, as measured by the S&P 500, were down -4.1% in August. International Equities in developed markets erased -4.8%[x], while Emerging Market Equities interestingly gained +0.4%.[xi] Fixed income lost -2.8% as measured by the Bloomberg U.S. Aggregate Index[xii] as the 10-Year U.S. Treasury bond yield rose +49 basis points to end the month at 3.13%.[xiii] Gold fell -2.8%[xiv] and crude oil lost -9.2%[xv] as the U.S. Dollar Index gained +2.8%.[xvi]
At the end of a market cycle, bear market rallies like the recent one from mid-July to mid-August are not uncommon and ultimately painful to optimistic buyers. According to the Wall Street Journal, “it is the worst year for buying the stock-market dip since the 1930s.”[xvii]
Pain remains the operative word all around. “While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses. These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain”, said Chairman Powell.[xviii]
Slower Growth and Softer Labor Markets
Markets have been volatile since Powell’s Jackson Hole speech as investors try to determine how fast and how high the Fed will raise rates, and perhaps most importantly, how long before the Fed cuts rates. It is our opinion that inflation will remain elevated for longer than many may hope for and as a result, the Fed will need to continue raising rates in efforts to fight inflation. Indeed, Chairman Powell said, “Reducing inflation is likely to require a sustained period of below-trend growth. Moreover, there will very likely be some softening of labor market conditions.”
Lower Asset Prices
The Federal Reserve’s doubling of its balance sheet sent a big liquidity wave through the economy that helped increase prices of assets from houses to stocks. As of September 14, 2022, the Federal Reserve balance sheet was $8.8 trillion, roughly double the $4.3 trillion pre-pandemic level on March 11, 2020, and only slightly lower than the $8.9 trillion balance as of June 1, 2022, the day the Federal Reserve began systematically reducing debt.[xix]
Long-time readers of our Asset Management updates may appreciate that we have been concerned about debt for some time. We discussed the Fed balance sheet more than a year ago in our June 2021 CIG Asset Management Review: Inflation and Fragility.
This same Federal Reserve is now intent on draining liquidity out of the economy to combat inflation. What will happen to these inflated asset prices as the Federal Reserve attempts to take liquidity out of the economy as it sells bonds to reduce its balance sheet and takes in hundreds of billions of dollars in cash?
Higher Government Debt Burden
The pandemic greatly increased the indebtedness of the United States. The total federal debt at the end of 2Q 2022 totaled $30.6 trillion, +32% more than the $23.2 trillion in early 2020.[xx]
We believe there is a consequence to all this debt and that this amount of debt is becoming unwieldy. The U.S. Treasury has paid out $590 billion in interest on its debt since October 1, 2021, when the Federal government’s fiscal year began.[xxi] This interest expense is quickly approaching the $777 billion that Congress approved for 2022 defense spending and is approximately 2.5% of the roughly $24 trillion annual U.S. economy.[xxii] If the economy is able to grow at a healthy pace, many may overlook the interest on the U.S. debt, but in a recession, this interest expense becomes magnified as the total output of the economy shrinks. Tax hikes may very well be in our future as the government tries to manage this debt. We would not be surprised to see taxes on capital gains increased in the near future.
Given this pain, why would you leave your hard-earned assets in a less active, less flexible account?
We took steps in our actively managed strategies in 2021 to significantly reduce risk versus the benchmarks and it continues to be rewarding. Publicly traded alternatives, which are generally less correlated to market movements, have also been part of our focus. Most recently, during the last week of September we reduced domestic equity and fixed income exposures in both the CIG Dynamic Growth and CIG Dynamic Balanced strategies and allocated the proceeds to cash.
Through 8/31/2022, our CIG Dynamic Growth Strategy composite has avoided approximately 50% of the losses of the growth benchmark and our CIG Dynamic Balanced Strategy has avoided approximately 55% of the losses of the balanced benchmark.[xxiii]
Meanwhile, anecdotally, we suspect that assets held in traditionally less flexible, company-sponsored 401(k) and 403(b) plans or in less actively managed accounts may have experienced greater losses. We would suggest that you review your recent statements or discuss this with your investment advisor when they call you next.
We would welcome the opportunity to connect with you via voice or email to discuss market challenges and opportunities, as well as the benefits of active investment management.