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2022 Q3

I think back to when I was a young boy, possibly 9 or 10, and like most boys at that age, I wanted a new bicycle.  My friends and I would set up ramps on top of tree logs, or concrete blocks, and see who could jump the highest or furthest.  I had seen a bike that had a shock absorber, and I knew I needed that bike.  It would help with the jumping - it was almost a singular focus, and no other purchase or gift would matter.  The markets, like me as a young boy wanting that bike, are almost singularly focused on getting one thing:  the Federal Reserve (Fed) to stop their aggressive tightening of interest rates.

A lot of you reading this may not recall a period of inflation like we are currently experiencing.  We understand this can cause concern.  However, the economy is more resilient than most give it credit for and has a way of establishing a new equilibrium given an appropriate amount of time.  It is also in these times that we find opportunities. 

This is a difficult market, plain and simple.  All major U.S. indices hit a new low for the year on the last day of the quarter.  With the S&P 500 down almost 24% for the year, and the Nasdaq down 32%, typically we would expect fixed income to help.  However, with the Fed’s aggressive policy on raising interest rates, fixed income, as measured by the iShares Core U.S. Aggregate Bond ETF (AGG), declined almost 14.5%.  The declines we’re seeing are indicative of a bear market.  Over the past twelve years, we’ve become accustomed to quick recoveries after large declines, but that was due to the prolonged bull market after the 2008 financial crisis.  Bear markets behave differently.  The average bear market usually lasts around 10 months and can have multiple rallies and retesting of lows during this time.


As I have shared with many of you, I am not worried nor am I concerned.  I am frustrated with the lack of coordination between fiscal and monetary policy.  For example, every spending bill that is passed, at this point in the economic cycle, may have to be offset by more tightening by the Fed.  But this too will end.  We are beginning to see signs that inflation is starting to diminish in multiple areas.  However, the Fed has a credibility problem given it waited too long to begin raising interest rates beyond the point that is necessary and emphatically stated inflation was “transitory.”  Because of this, it will likely overcompensate by

raising interest rates beyond the point that is necessary, and this is what has concerned markets this year.

Over the course of the year, we have adjusted the portfolios to reduce risk and foster principal preservation.  While we have been successful to a degree, as mentioned above, there is no place to hide.  We have protected portfolios against rising interest rates by shortening duration and buying individual bonds which have positive returns.  In addition, our repositioning of assets between equities and fixed income, and from cyclicals to staples, health care, and defense has benefited the portfolios as well.


Looking forward, I want to focus on the opportunities that are emerging.  Currently, we expect another 0.75% rate increase at the beginning of November, after which we anticipate the Fed will start slowing its rate increases.  We are already beginning to remove or reduce some of the protective positions in anticipation of the completion of this bear market cycle.  In addition, equity markets typically begin recovering months before the economic cycle turns back up, and this is coming closer.  While this seemingly drawn-out market pain may feel unsettling, longer-term investors have typically been rewarded very nicely for their patience and temperament.  According to a J.P. Morgan study, “looking at the past 8 instances in history when the S&P 500 reached a -25% drawdown from its prior high, the index returned an average of +7% over the following 6 months, +27% over the next year, and +40% over the next 2 years.  While past performance is no guarantee of future results, positive returns may not be too far on the horizon”.  

We will get through this and come out stronger on the other side.  We are here to talk and will continue adjusting the portfolios as necessary.  However, we are not out of the woods yet and will likely experience further volatility over the next few months, while the economy recalibrates.

To end my story, I did get the bike – and I loved it.  The market will eventually get a pause on interest rate hikes and will love it, the Fed just needs a little more time.  Thank you again for your trust.  We value your confidence in us.

Marc Henn, CFP®