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As we close out the remainder of 2022, there is very little doubt this will be a year for the financial history books. As we stated in our December 2021 update, the S&P 500 was “out of bounds” and needed a correction in price and time. At GWS, we have been calling for a normalization to bond yields for several years, but had no idea the velocity of the move that would ensue.
The 10-Year Treasury yield began 2022 at 1.63%*, after having a low in 2020 at 0.52%. Today, as of 11/18/22, the yield is 3.829%. The yield has increased 148.03%. This is the largest increase in yield recorded since data going back to 1963.
However, what is of most concern to investors is the 2-Year Treasury has a yield of 4.531%, an inverted yield of -0.71%. What is the significance of this inversion? The 10-year is controlled mostly by investors and the 2-year by the Federal Reserve interest rate hikes, and very often is a signal that a recession is on the horizon.
For the first time in nearly two decades, we can now offer short-term Treasury bonds to investors currently yielding over 4%, subject to change. If you have over 100,000 account and would like to know more, please reach out for a discussion.
With inflation over 2% and the job market strong, it puts the Federal Reserve in a tough spot. They are mandated to drop inflation even if a recession is the result. We have been arguing that all the monetary stimulus from the FED and the government during Covid, would result in problems for the financial system. We felt it was just a matter of time; the bubbles in crypto, the stock market, bond market and real estate would eventually start popping. How many times in your life have you seen housing prices rise by double-digit percentage points in just a few years? Only when monetary policy is too friendly. At some point, the party has to end.
What does all this mean for investors? While the stock market can ebb and flow in the short term, it’s true colors are revealed over time. For next year, it would make sense there could be a buying opportunity that could potentially present itself. There are many unknowns, such as how high will the Federal Reserve raise interest rates? Will the lagging effects of the unusually high interest rate hikes present themselves as damaging the economy, resulting in a recession? If so, will the recession be mild or deep?
Historically, the stock market does not fare well in a stagflation environment. If inflation falls to the 3-5% range, it still keeps investors unwilling to “pay up” for stocks, like they have over the past few years. With that said, the bond market has become more attractive from a yield perspective and may deserve attention. High quality dividend paying stocks could prove to be an attractive investment while the market grapples with these issues.
Through the end of the year, historically the stock market looks past all the issues and likes to put on a show. We will see if that is the case this year, but the bottom line for us is that until the Federal Reserve makes clear they are done raising rates, the stock market is going to ebb and flow and be very difficult to navigate.