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Monthly Market Commentary – September 2022



“Today, my remarks will be shorter, my focus narrower, and my message more direct”. That’s how Jerome Powell, the Chairman of the Federal Reserve, started his speech on August 26. The Federal Reserve has a dual mandate – stable prices and full employment. The word “inflation” appears 47 times in the speech. “Price Stability” ten times. “Employment” shows up only once and in the same breath as Powell reminds us that the “successful Volcker disinflation in the early 1980s followed multiple failed attempts to lower inflation over the previous 15 years”. Powell intends to be Volker, Greenspan, or Bernanke. He will not be Arthur Burns.

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In the 1980’s, market participants tried to decipher the Fed’s policy preferences via the market’s movements. Then, we tried to make any sense we could of the eloquent verbosity of Greenspan. Bernanke and Yellen were straightforward, traditional economists guiding our economy through and out of a near depression experience. Powell’s time as Chairman has been marred by missteps and seemingly succumbing to political influence. This speech was a departure. A line in the sand. A parent reigning in an out of control child.

For the past few months, I have been saying that our cautious approach to asset allocation is a result of a firm belief that the Federal Reserve will fight inflation and that market participants are wise to assume that as the base case in planning. After the Federal Reserve raised interest rates by 75 basis points (0.75% points) at its last meeting, Chairman Powell’s comments somehow led some markets to believe that a “pivot” was near; that the Federal Reserve was nearing an endpoint for tightening policy and that easier policy might come sooner rather than later.

June’s midmonth rally, July’s jubilation, and August’s absurdities reflected a false belief that a pivot from the Fed was coming. When I mention August’s absurdities, I think about interest rates coming down, stocks going up, and of course, the return of “meme stocks” like AMC, Gamestop, and Bed Bath and Beyond making the headlines again. A 0.0% month over month inflation rate of change as oil prices, airline fares, and used car prices declined gave a false hope that the beast of inflation had been tamed. It has not. As Powell noted in his speech, “Restoring price stability will likely require maintaining a restrictive policy stance for some time. The historical record cautions strongly against prematurely loosening policy.” There is no pivot in the near term.

I have had a number of conversations with clients about the best course of action during this time. The most common question is, “Should I get out?” My answer is a less than emphatic, but practical, “no.” Getting out – going to cash – is a timing decision that begs the question, “When do I get back in?” This kind of market timing is extraordinarily difficult and I do not profess to own the crystal ball for making such decisions. Markets constantly deliver prices across the spectrum of assets. Each day, we make relative value judgements about the price of one asset or asset class versus the relative attractiveness of the price of another asset or asset class. These types of judgments tend to enable us to buy stocks when they are cheap relative to bonds, or sell stocks when they are expensive relative to bonds. We essentially allow the markets to tell us when to rebalance. This worked out well in March of 2020 as stocks dropped sharply and our asset allocations went far away from the central target and closer to the outer bounds of each client’s risk tolerance/investment objective. As such, we bought stocks and sold bonds. In May, we chose to shift all client asset allocations to a less volatile mix of assets. Stocks represent a lower percentage in client accounts by risk tolerance. Further, the types of bond funds we have invested in should reduce volatility of price changes as interest rates rise when compared to the benchmark or broad market.

Finally, we watch our basket of stocks like a hawk. Of the thirty-five stocks on our “Approved List”, twenty-eight (or 80%) reported quarterly earnings that met or exceeded Wall Street expectations. The stocks that missed earnings expectations seemed to have one-off events and management’s forthrightness about the issues and how they planned to correct those issues going forward were the hallmark of what we like to see in successful management teams.

The last few months, I’ve included many charts and graphs talking about esoteric economic topics. This month, I have only one chart. Larry Kudlow, former Director of the National Economic Council of the United States and business television anchor, famously says “Profits are the mother’s milk of stocks.” The chart below shows the profits of S&P 500 companies in orange, and the S&P 500 Index price in blue. You’ll certainly note that as profits go up, the market goes up too. Over the long run, corporate profits tend to go up at 7-8% per year. Add in a 2-3% dividend yield and you get the long term return assumptions of large company stocks of about 10%.      

Powell notes in his speech that the Federal Reserve policy is likely to induce slower growth. Slower growth may mean slower profit growth, but slow growth is growth nonetheless. As prices on stocks go down, while the earnings potential for those companies continues to grow, they become more valuable and attractive. Price is what you pay. Value is what you receive. The best companies will find ways to creatively navigate this environment. Our mission is to find those growing companies and put their stocks in your portfolio at reasonable prices.

The jobs data continues to be strong. The U.S. economy continues to be the strongest around the world. Powell wants to inflict economic pain as the Federal Reserve proceeds. “Pain” is mentioned twice in the speech. With our cautious approach to asset allocation, a focus on relative value, and a relentless analysis of the securities in your portfolios, we will get through the pain together. While it may seem trite, it is important for you to stay focused on your long term goals and objectives. Reach out to your AAFMAA Wealth Management & Trust relationship manager and take advantage of our financial planning expertise.

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