2022 Q3 Letter to Clients

October 18, 2022
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October 14, 2022


A gloomy September

For reasons not fully understood, September has historically been the worst month for stocks, according to the average S&P 500 return for each month (St. Louis Federal Reserve dating back to 1970).

As illustrated in Table 1, this past September was indeed a weak month. It was also the worst month of 2022 for the S&P 500 (MarketWatch, monthly return data).

Table 1: Key Index Returns

 

MTD %

YTD %

Dow Jones Industrial Average

-8.8

-20.9

NASDAQ Composite

-10.5

-32.4

S&P 500 Index

-9.3

-24.8

Russell 2000 Index

-9.7

-25.9

MSCI World ex-USA*

-9.6

-28.0

MSCI Emerging Markets*

-11.9

-28.9

Bloomberg US Agg TR Value Unhedged USD

-4.3

-14.6

Source: Wall Street Journal, MSCI.com, Yahoo Finance, Bloomberg

MTD returns: August 31, 2022—September 30, 2022

YTD returns: December 31, 2021— September 30, 2022

*In US dollars

What worked against stocks last month?

Headwinds that have battered markets this year remain in place.

For starters, rate hikes. The Federal Reserve hiked the fed fund rate another 75 basis points (1 bp = 0.01%) to 3.00%‐3.25% last month, maintained its aggressive stance and suggested in its economic projections that we might see another 125 bp by year-end.

Why is the Federal Reserve raising interest rates at a pace not seen since the second half of 1980? (Rate data from the St. Louis Federal Reserve) Inflation remains stubbornly high.

Ultimately, price stability is the foundation of a strong economy and long-lasting economic expansion. But the Fed's rate-hike hammer hasn't landed without pain.

While the Federal Reserve is not publicly forecasting a recession, its latest projections, released last month, show it believes its inflation-fighting campaign will boost the unemployment rate next year.

Investors are also growing concerned the economy could sink into a recession next year, which would depress earnings.

In addition, the sharp increase in interest rates has led to a much stronger dollar since parking cash safely in the U.S. offers a higher return to foreign investors. 

 A strong dollar reduces the price of imported goods and the cost of an overseas vacation. Still, the rapid increase in the greenback against foreign currencies is raising fears the Fed could unintentionally "break" something in the financial markets, either at home or abroad. 

 It happened during the early 1980s, when sharp rate hikes put a heavy strain on Latin America, and again in 1994, when rate hikes exacerbated problems in Mexico, leading to a bailout. It also led to bankruptcy in Orange County, California.

We're not forecasting an imminent financial crisis, and any unexpected shift by the Federal Reserve could alleviate financial market pressures.

That said, we recognized that the Fed's steely resolve to bring down inflation has created pain in financial markets.

 Inflation & Interest rates 

We think headline inflation may not have peaked, and the ongoing pressures from a tight labor market, overinflated real estate prices, and high energy prices will likely keep inflation far above the Federal Reserve's official 2% target for longer than they would like. Research forecasts inflation falling to slightly under 5% by the middle of 2023. Most economists agree that dropping it below the 3-4% range will probably be more difficult. Those hoping for a quick end to tightening or pivoting in Fed policy could be sorely disappointed. See the table below taken from the Bureau of Labor and Statistics website:

Table A. Percent changes in CPI for All Urban Consumers (CPI-U): U.S. city average

https://www.bls.gov/news.release/cpi.nr0.htm

Bear history

Taking a longer-term view, we want to emphasize that bear markets eventually end, and bottoms typically occur when negative sentiment is high.

According to [[https://www.schwab.com/learn/story/market-volatility Charles Schwab]], the average bull market since the late 1960s ran for about six years, delivering an average cumulative return of over 200% for the S&P 500 Index. 

The average bear market lasted roughly 15 months, with an average cumulative loss of 38.4%. 

The longest bear market lasted just over two and a half years, followed by a nearly five-year bull run. The shortest occurred in 2020 and lasted only 33 days.

One final remark

We moved portfolios to more defensive positions early in the year by reducing foreign and U.S. equity allocations. Unfortunately, the Fed's action of rapidly raising rates put tremendous pressure on the bond markets as well, and they have experienced an unusually sharp drawdown. Your portfolio remains defensively positioned, and we plan to remain so until the evidence shows us the effects of the Fed's actions are beginning to dissipate. We have been adding short-term U.S. treasury bonds in portfolios since the yields are up over 3% and rising while we wait. As the economy adjusts to higher interest rates, markets will also give us the next great buying opportunity. 

October has a spooky reputation—1929, 1987, 2008. Since the 1970s, it has been a volatile month (Advisor note: standard deviation of monthly returns of 6.3% is the highest monthly reading). Still, according to S&P 500 data (St. Louis Federal Reserve), it has been a strong month.

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Personal Notes @ SVWA: 

Tracy and Roberta - went to Yellowstone National Park in late September. The park was just about to close, but there was wildlife aplenty. They worked with park conservationists at the Forever Yellowstone Foundation, tracked wolves, and took part in a geological park tour. Yellowstone is our oldest National Park and a real treasure. 

Scott and Erin – spent some time in Tahoe and enjoyed having family visit us over the summer.    

Scott Yang and his family - had a nice summer, traveling to Las Vegas and Boston to check out the sights with good dining opportunities and looking forward to a cooler fall and a rainy winter. 

Mo and family - planned a trip to visit the 'happiest place on earth,' also known as Disneyland and California Adventure parks. It has been a decade since our last visit, and there were new attractions and food to experience.  

Lisa Ozaki - went to Santa Barbara in August for a quick getaway and enjoyed time reading at the beach. She also finally became a CFP® and celebrated with her sister and fiancé. 

Charles Tran - enjoyed a nice vacation with friends and learned a lot during his time at the FPA NexGen conference. He hopes to bring some of the learnings from the conference back to SVWA. Also, after shaving his head for the summer, he is growing his hair back out again for winter. 

Katelyn – had a wonderful time on family trips to Las Vegas and Boston over the summer, despite completing a challenging online accounting course through West Valley. Since then, she's settled into a new place in downtown San Jose with her close friends. She has been enjoying her second year of college and is looking forward to more memorable moments.

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We trust you've found this review to be educational and helpful. Please contact us if you have any questions or want to discuss any matters.

As always, we are honored and humbled that you have allowed us the opportunity to serve as your financial advisor.

Gratefully yours, 

The Silicon Valley Wealth Advisors Team

Tracy Lasecke, CFP®            Scott Yang, CPA, CFP®          Scott Ponder, MBA, CFP®   

Lisa Ozaki, CFP®                   Monique Ruiz                         Charles Tran                              Katelyn Yang

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