Key Events: Russia actions exacerbate concerns about inflation and the US economy
Two key events drove the markets this week. First, in a surprise escalation, Vladimir Putin ordered the partial mobilization of the Russian population, repeated threats of nuclear war, and staged annexation referendums in occupied areas.
Later Wednesday afternoon the Federal Reserve met and raised rates .75%, as expected. In the outlook and press conference, the Fed confirmed its commitment to fight inflation despite the expected rise in unemployment, this despite the Fed’s dual mandate of price stability and full employment.
Market Review: Markets retest summer lows
The stock market sold off significantly throughout the week. After selling off 4.7% last week, the S&P 500 finished the week down another 4.6%. As happened last week, international stocks lost less than US stocks, although they are still down more for the year. The S&P 500 currently sits at its 2022 low while international stocks, measured by the MSCI EAFE, are down a further 4.8% below the June lows in US Stocks.
The more significant move was the sharp rise in interest rates, reflective of a reaffirmation of the Fed’s commitment to fight inflation. The two-year treasury yield closed the week at 4.19% on Friday, up from 3.49% at the end of August. Ten-year treasury yields also moved higher, ending the week at 3.68%, .51% below the two-year yield, an “inversion” in the yield curve. The increase in bond yields is in the top 10% of increases in the last 20 years over the 1 week, 1-month and 3-month time periods.
Outlook: Expect continued volatility while the markets seek to find a bottom
The inversion of the yield curve reflects the significant fear that the economy will go into recession and the Fed will need to lower rates in the future. Our base-case view is that stocks expect a mild recession, but further economic weakness could lead to further stock market losses. We will be watching the market action closely next week to confirm our thesis that a medium-term bottoming process is playing out. Valuations in both the bond and stock markets are compelling. As seen in the below chart, when investors are very bearish, such as in 2008, returns in the coming year tend to be very strong. While we don’t know where the bottom is, history – while not repeating – tends to rhyme, giving us some confidence in the outlook.
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