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Major stock averages hit new lows as inflation data remains high

Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy only when others are fearful.  – Warren Buffett 

The major stock averages continued their downward trend last week and closed on Friday at new 52-week lows as fears of a global recession grew amid stubbornly high inflation and slowing economic growth. The stock losses were nearly 3% as the Dow Jones Industrial Average fell into bear market territory and the S&P 500 Index and the Nasdaq Composite Index posted their first three-quarter losing streak since 2009. There were very few positives last week as investor sentiment remains extremely negative. The August core personal consumption expenditures (PCE) price index, which the Federal Reserve favors as the broadest indicator of where prices are heading, was slightly higher than expected for the month and increased 4.9% from a year ago, also higher than forecast. The Fed’s aggressive rate hiking campaign that has seen the federal funds rate raised to between 3.0% and 3.25%, the highest level since 2008, has yet to achieve its desired effect of bringing down prices. The Fed has implemented three 75 basis point (a basis point is one hundredth of one percent) hikes already and plans additional increases to reach between 4.25% and 4.5% by year-end. But there is a lag effect between each increase and assessing its effect. Chicago Federal Reserve President Charles Evans said last week that he’s concerned that the Fed is raising rates too far, too fast, which leaves little time to measure the impact of each rate hike. Apple, whose market value comprises 7% of the S&P 500 and over 12% of the Nasdaq 100, also contributed to the negative sentiment last week when it announced that it is scrapping plans to increase iPhone production after demand fell short of expectations. The stock was downgraded by an analyst to neutral and finished the week significantly lower. In a perverse way, there was some good news last week as the American Association of Individual Investors survey showed that bearish sentiment topped 60%, the first time since 1987 that bearish sentiment had exceeded this level two straight weeks. Contrarians believe that this means there are fewer sellers left to push prices lower and that the market is washed out. Substantial advisor pessimism ultimately signals a market bottom. It would also help if there was convincing evidence that inflation is, indeed, declining, allowing the Federal Reserve to become less hawkish in its monetary policy.

Last Week

The final reading of second quarter GDP showed that it fell 0.6% on an annualized basis to go with a decline of 1.6% in the first quarter, meeting the technical definition of a recession. August durable goods orders fell slightly and less than expected, but core capital goods orders, which is a good measure of business investment, rose at the fastest pace in 8 months. Weekly jobless claims were 193,000, below the estimate of 215,000 and last week’s adjusted total of 209,000. The consumer confidence index for September surged to the highest level since April and was much better than expected as consumers were more upbeat about the economy due to rising wages and falling gas prices. The University of Michigan consumer sentiment index for September was also higher than in the previous month.

For the week, the Dow Jones Industrial Average fell 2.9% to close at 28,726 while the S&P 500 Index also dropped 2.9%% to close at 3,586. The Nasdaq Composite Index declined 2.7% to close at 10,576.

This Week

The September employment report is expected to show that about 250,000 new jobs were created, and that the unemployment report remains unchanged at 3.7%. The ISM Manufacturing and Services Purchasing Manager’s Indices (PMI) for September are both expected to approximate readings in August and remain above the 50 threshold that indicates expansion. August construction spending is forecast to decline slightly.

The only prominent companies scheduled to report second quarter earnings this week are Acuity Brands, Conagra Brands, Constellation Brands and McCormick.

Portfolio Strategy

There not only has been a bear market in stocks this year, but bonds have also experienced the same fate in a sell-off of historic proportions. Bond prices and bond yields move in opposite directions and as the Federal Reserve has raised interest rates to fight high inflation, bond prices have plunged while bond yields have surged, producing negative total returns for investors. The iShares Core U.S. Aggregate Bond ETF (AGG), which replicates the performance of the Bloomberg U.S. Aggregate Bond Index of investment -grade corporate bonds, is down 16% this year, its worst performance since 2004. Long-term Treasury bonds have fared even worse with losses that exceed 25%. The result of higher bond yields is that there finally is value in fixed income investments in terms of providing a decent level of income. The 2-year Treasury yield has risen to 4.2% while the 10-year Treasury yield has climbed to 3.8%. The Federal Reserve’s interest-rate hiking cycle, although not finished yet, is expected to reach 4.4% at year-end from 3.25% now and then level off. This forecast implies that the Fed is closer to the end than the beginning of this tightening process, making bonds relatively attractive with yields at or above 4%. Short duration bond yields are high enough to withstand a few more rate hikes and still provide investors with positive total returns. Yields on investment-grade corporate bonds are even more attractive as they yield at least 100 basis points (a basis point is one hundredth of one percent) more than a comparable Treasury with the same maturity. Investors would be wise to continue to favor short-duration bonds, though, since inflation remains too high and the Federal Reserve could raise interest rates even further than originally forecast.