Our Thoughts on Third Quarter 2022
Matt Johnson, CFA® - Andy Nugent, CFA®
Market Recap, Portfolio Analysis, and Review
The Third Quarter of 2022 started off strong with the market rebounding in July only to fizzle out in August and September. The Fed aggressively raised rates during the quarter, and it seems as if they will continue to do so. We expect inflation to remain high and are seeing further signs of a weakening economy with Federal Express declaring a decreased demand and Nike having increased inventory during the last quarter. Many commodity prices dropped significantly over the last month and our overall thoughts are that this recession may last a while.
While it can be stressful to watch your portfolio as the market goes through its up and down cycle and we encourage you to remember you are investing to meet your long-term financial goals. Historically, over the last 50 years, we have only seen three calendar year returns where the S&P was down more than 20%. Each time, the following year produced returns greater than 20%. Prior to 2022, we had an amazing 10-year run. With everything going on in the world today, a pull back is not surprising. We are not predicting future returns but making the point that the market is resilient, and we should expect market pull backs through the course of our investment life. It is a reminder to stay disciplined, use market volatility to add quality when the price is right and stick to the long-term plan. We continue to seek opportunities to purchase quality companies at a discount to where they historically trade. As the old financial disclaimer goes, past performance is no guarantee of future returns.
Inflation is measured by the Consumer Price Index (CPI) and Personal Consumption Expenditures (CPE). The CPI measures the average change in price of a basket of goods and services. The CPE is the CPI excluding food and energy components. In August, we saw a small dip in inflation levels for both, but the decline was less than expected and remains elevated. Our thoughts are that with current economic conditions, it will likely take months or even years to get back to the Fed target of 2%.
The Fed continued raising rates in the quarter. In fact, they raised rates two separate times. Each by .75 basis points. That makes five (5) rate hikes totaling three percent (3%) this year alone which has been very aggressive. We expected the Fed to anticipate inflation after the government added trillions of dollars to the economy and what we are seeing is the outcome of those actions. They are expected to raise rates in the fourth quarter as well as they seek to make up for lost time.
As these interest rates rise, mortgage rates also increase. Per Bankrate, the average 30-year fixed rate mortgage rose from 5.85% to 6.83% at quarter end. This means that for a given monthly payment, the amount of the loan a borrower will qualify for will be smaller. This will likely have a negative effect on the housing market.
On a positive note, yields on Treasuries are increasing, with short-term treasuries yielding as much or more than longer term treasuries. Six-month treasuries are yielding almost 4%, which is significantly better than money market funds which are yielding about 2.5%. However, to ensure realizing these higher yields a bond is held to maturity and the money is tied up until maturity.
The S&P 500 continued its downward trend giving back another 5% in the quarter and nearly 25% year to date. Most sectors were negative apart from Consumer Discretionary and Energy which managed small positive performance. Understandably, Real Estate, with rising rates, was off over 10% in the quarter as was Communication Services. As you can see from the Sector Index chart above, many more sectors are trading near the bottom of their 52-week price range. While this may allow us to buy some quality names at a discount, we continue to be slow to add money to the market and maintain higher cash balances. As a matter of philosophy, we seek to purchase quality investments that will provide growth and earnings to achieve our portfolio goals. We have a proprietary due diligence process and system that we use to determine whether a purchase will perform to our outlook and expectations. We are currently holding cash waiting to make purchases in several sectors where the investment opportunity will meet our philosophy.
Materials – Materials performed slightly worse than the market in the quarter but we are seeing some promising opportunities. We purchased Dow, Inc. as at the time it was trading at single digit multiples of both Price to Earnings and Price to Cash Flow while offering dividends north of 6% making this a company that fits nicely into the portfolio.
Energy –Energy started the quarter with positive performance in the quarter only to give back most of its gains in September to end the quarter only slightly positive. With oil prices expected to remain high, this is a sector we are seeking to have some exposure. After being up nearly 50% in 2021, prices have not come down enough to warrant a purchase and we continue to monitor this sector closely looking for an entry point. Price matters, and we will remain steadfast in investment process and will not overpay to have exposure. With the recent announcement that OPEC will reduce the production of oil by two million barrels a day, we can also expect the pain at the pump to continue.
Healthcare – The healthcare market performed well in the third quarter and we like this sector as it will always be in demand. Most of the companies are well capitalized giants that the world depends on. Solid financials, higher than market dividend yields and price contraction has us watching this sector closely seeking to increase our positions at some point.
As of the end of the third quarter, we are experiencing maximum pessimism in the markets. High inflation, rising interest rates, OPEC reducing oil production, the ongoing war in Ukraine, and the stock market down 25%. We do not know where the stock market will finish the year, and we realize it is difficult to watch portfolio values decline to this extent, but we urge you to stay the course. We are always available to have a conversation and review your portfolio and we thank you for your continued confidence allowing us to help reach your financial goals.
We thank you for your continued confidence allowing us to help reach your financial goals.
Matt Johnson, CFA® Andy Nugent, CFA®
Sage Capital Advisors, LLC is a Securities and Exchange Registered Investment Advisor. Sage Capital Advisors is headquartered in Sioux Falls, South Dakota. Advisory services are only offered to clients or prospective clients where representatives of Sage Capital Advisors are properly licensed or exempt from licensure. This market commentary is solely for informational purposes and should not be construed as investment advice, it is only intended to provide education about the financial industry. Historical performance results for investment indices and/or categories have been provided for general comparison purposes only, and generally do not reflect the deduction of transaction and/or custodial charges, the deduction of investment management fees, or the impact of taxes, all of which would have the effect of decreasing historical performance results. Indices are unmanaged and cannot be invested in directly. It should not be assumed that your account holdings correspond directly to any comparative indices. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered unless a client service agreement is in place.