September 30th, 2022 / 4:42 PM

Dear Friends : In the last several weeks, we have continued to face elevated uncertainty in financial markets due to high inflation and rising interest rates, and we thought it was an important time to take stock with the final quarter of 2022 just ahead. It has been a difficult year...a volatile year, not only for investors but also for households and businesses as we all try to navigate higher prices and borrowing costs. There will be some challenges ahead for the economy as the Federal Reserve (Fed) continues to raise rates to control inflation. We believe the Fed is doing the right thing for the long-term health of the economy, but it does increase near-term economic risks and create volatility. Given these risks, we are receiving questions about stagflation and concerns that we may again be facing the investment environment of the 1970s. But this is not your 1970s-style stagflation. While growth has slowed and inflation has been high, the unemployment rate has remained very low. The average unemployment rate during the stagflationary years in the 1970s and early 1980s was 6.7%, compared with just 3.7% in August of this year. Unemployment will move higher, but it’s likely to remain low by comparison, giving the economy more resilience than in the 1970s. At the same time, inflation is decelerating, and in some areas showing a solid decline. Gas prices and agricultural commodity prices, for example, have declined throughout this summer. Moreover, rents in some areas of the country are dropping, durable goods prices are declining, and many import prices are falling. Other areas such as lumber prices and used car prices are showing consistent month over month declines as well.

When our central bankers are sufficiently convinced, the Fed can slow the pace of tightening as inflation moves closer to their long-run target. Some of the recent market volatility came from mixed inflation signals, so as the signals become more aligned, we expect volatility will fall and investor sentiment will improve. That level of bearishness right now is very high, but it’s important to remember that historically extreme negative sentiment has often been followed by strong market performance. To take just one example, the American Association of Individual Investors (AAII) has been doing a weekly survey since 1987. Last week’s survey had a level of bearishness seen only four other times before. S&P 500 returns a year later in those cases averaged over 30%. We don’t know whether that will happen again, but there’s still an important takeaway. As we experienced in 2020, when a lot of negative sentiment is being priced into markets, it may set the bar low for stocks to outperform expectations. We also have some positive seasonal patterns ahead. November through April are historically strong months for equities. Stocks have also done well after mid-term elections. And the third year of the four-year presidential cycle (which we enter in 2023) has historically been the strongest for stocks. The best three quarters historically of the presidential cycle start next week, in October.

The recent market volatility is concerning, and we can’t be 100% certain when the volatility will end. The markets are basically seeking a sense of equilibrium, after going through the extremes caused by Covid-19 and the ballooning money supply which helped to create the excess inflation we now have, to the recent interest rate increases that are being used to tame inflation. The markets and economy will find that balance, as we believe conditions continue to indicate that better times are ahead. We will continue to closely monitor the markets. Please feel free to contact us with any questions you may have.

Sincerely,

John M. Brueggeman, CMFC Senior Managing Director - Principal / Portfolio Manager Viceroy Wealth Counsel

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