The third quarter marked a change in attitude.
So far, 2022 has been a tough year for investing. We’ve experienced an unusual phenomenon – the simultaneous decline of stock and bond markets. Throughout the third quarter, investors’ concerns focused on global instability, rising prices and the possibility that central bank efforts to tame inflation would cause economic growth to falter. The result has been tremendous volatility in stock and bond markets.
Early in the third quarter, U.S. stock markets gained ground as investors latched onto the idea that inflation had peaked, and the Federal Reserve would soon moderate the pace of rate hikes. Following the release of July’s Consumer Price Index (CPI), Carleton English of Barron’s reported:
“Wall Street got a dose of good news this week. It also got a little ahead of itself. Inflation slowed in July, according to Department of Labor data released on Wednesday…It makes sense that investors would celebrate the easing of prices. But it may be too early to pop the Champagne – inflation standing at 8.5% is still a long way from the Federal Reserve’s target of 2%, and the Fed is likely to continue tightening until it is under control.”
U.S. stock markets trended higher through mid-August when Fed Chair Jerome Powell made it clear the Fed did not share investors’ optimistic inflation outlook. It still viewed inflation as a threat and planned to continue to raise rates aggressively into 2023.
Other central banks concurred. Last week, Katie Martin of Financial Times reported, “In an extraordinary sweep, central banks from the U.S. to Switzerland embarked on what looked like competitive policy tightening…10 central banks delivered a massive combined total of 6 percentage points of rate rises just this week. Several rises, including the latest from the U.S., were of some 0.75 percentage points, three times the usual scale of rate moves.”
Aggressive central bank tightening caused investors to reassess their expectations. The result was a market sell off. “In the month since Federal Reserve Chair Jerome Powell laid down a hard line on inflation, stocks have suffered double-digit losses, chasms have opened in global currency markets, and yields on the safest U.S. government debt have surged to their highest levels since the dark days of the financial crisis nearly a decade and a half ago,” reported Howard Schneider of Reuters.
There is a concept in financial markets known as capitulation. It occurs when fear takes hold. Investors abandon hope that the stock market will deliver positive returns and they sell. Capitulation often is a sign the market has bottomed, reported Nicholas Jasinski and Jacob Sonenshine of Barron’s. In recent weeks, investors have been selling, but some say the market has not yet reached capitulation.
If you’re tempted to sell, think carefully. The wiser course may be to stay invested. A recession is at least partly priced into current U.S. stock prices. In addition, the strength of the dollar will help the Fed’s effort to bring inflation down, reported Financial Times.
It’s important to remember that stock markets are leading indicators. They reflect what investors anticipate will happen in the future. As a result, the market often bottoms during a recession and begins to rise before the recession ends, reported Sergei Klebnikov of Forbes.
