Could the Worst Be Behind Us?

Given the timing of the recent increase in market volatility, we feel now is a good time to take stock of all that has transpired in 2022.

First, It has been a difficult year on many fronts.  Not only for investors but also for households and businesses as we all navigate higher prices and borrowing costs. There will be challenges ahead for the economy as the Federal Reserve (Fed) continues to raise rates to control inflation. We believe the Fed is doing the right thing for the long-term health of the economy, but it does increase near-term economic risks.

The Fed has two primary mandates: (1) monitor and control inflation, and (2) managing healthy employment levels. Given this years headlines, we are receiving many questions about inflation and concerns that we may again be facing the investment environment of the 1970s. But this is not your 1970s- style stagflation (high inflation, with high unemployment and decrease economic growth). While growth has stalled and inflation has been high, the unemployment rate has remained very low!  The average unemployment rate during the stagflation years in the 1970s and early 1980s was 6.7%, compared with just 3.7% in August of this year. Unemployment will move higher, but it’s likely to remain low by comparison, giving the economy more resilience than in the 1970s.

Inflation is decelerating. Gas prices and agricultural commodity prices, for example, have declined throughout this summer. Moreover, rents in some areas of the country are dropping, durable goods (things we buy occasionally and last 3 years or more) prices are declining, and many import prices are falling. When our central bankers are sufficiently convinced, the Fed can slow the pace of tightening as inflation moves closer to their long-run target. Some of the recent market volatility came from mixed inflation signals, so as the signals become more aligned, we expect volatility will fall and investor sentiment will improve.

That level of bearishness right now is very high, but it’s important to remember that historically extreme negative sentiment has often been followed by strong market performance. To take just one example, the American Association of Individual Investors (AAII) has been doing a weekly survey since the 1987. Last week’s survey had a level of bearishness seen only four other times before. S&P 500 returns a year later in those cases averaged over 30%. We don’t know whether that will happen again, but there’s still an important takeaway. As we experienced in 2020, when a lot of negative sentiment is being priced into markets, it may set the bar low for stocks to outperform expectations.

We also have some positive seasonal patterns ahead. First, November through April are historically strong months for equities, and second, stocks have done well after mid-term elections. The third year of the four-year presidential cycle (which we enter in 2023) has historically been the strongest for stocks. 

The recent declines are concerning, and we can’t be certain when the volatility will end. We do know that current conditions continue to indicate that better times are ahead. Market volatility and negative sentiment can make it harder to make stay invested and make new investing decisions, but we believe the surest path forward remains sticking to your financial plan. 

Important Information

This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. Any economic forecasts set forth may not develop as predicted and are subject to change. 

References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.

All data is provided as of September 27, 2022.

Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services. LPL Financial doesn’t provide research on individual equities. 

All index data from FactSet.

The Standard & Poor’s 500 Index (S&P500) is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. 

This Research material was prepared by LPL Financial, LLC. All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy.

For a list of descriptions of the indexes and economic terms referenced, please visit our website at lplresearch.com/definitions.

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