Klingman & Associates, LLC

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Klingman Insights

The Federal Reserve and Market Volatility
September 25, 2022

As widely expected, the Federal Reserve raised short-term rates this week by 0.75%. In six months, the Fed has now raised these rates by 3% as they attempt to combat troubling inflation numbers. We believe these steps were necessary to play “catch up”, but the Fed’s aggressive stance on further hikes may be overdone. We believe inflation should decelerate alongside our economic growth, and often less talked about, money supply growth. We would like to see the Fed take a moment to assess how the economy reacts to their policy changes, but their latest interest rate projection and comments makes that now appear unlikely.

Equity markets have reacted unfavorably to these developments and perhaps will retest the June lows, a possibility we discussed on our July Capital Markets Outlook call. As we discussed in that call, there have been 11 bear markets as measured by the S&P 500 post World War II. Although each was different, on average they lasted 16 months with an average decline of 35%. The two most recent we surely remember, with prices falling 57% in the Great Financial Crisis and 35% in the COVID-19 lockdown. The current bear market is down 23% through the first 9 months of the year. Unfortunately we do not have a crystal ball showing us where the market will move in the short-term, but we believe we are much closer to the end than the beginning of this bear market. The labor market remains healthy, as do consumer and corporate balance sheets. Corporate revenue and earnings are expected to slow in the coming quarters, but have remained resilient despite recent pessimism.

One silver lining for us as long-term investors has been the ability to generate higher expected returns on fixed income portfolios. Higher interest rates are painful for borrowers, but represents opportunity for lenders, which we are as bond investors. We are finding opportunities to purchase corporate and municipal bonds at attractive yields not seen in many years. We also believe a more “normalized” interest rate environment will provide a better structure for the economy and financial markets long term.

While as long-term investors we understand that volatility is the price we pay for the returns we receive by investing in equities, it can be challenging in the short-term to any investor’s psyche. There is a temptation during a bear market, when it appears equities decline almost every day, to just “sell” and “take a break.” Studies show this seldomly works, and instead patience and discipline are rewarded. To that, we are rebalancing and tax lost harvesting in our clients’ portfolios. And being very patient.