The 3rd quarter of 2022 offered another tough period for the financial markets. International stocks led the way down, falling by over 10% for the quarter. US stocks (both large and small) fared better, but were still down for the period. Bonds continued to suffer in the face of rising interest rates.
Here are the returns for the major asset classes during the quarter:
To add insult to injury, the stock market threw out a giant “head fake” for during the 3rd quarter. Take a look at the chart below of the S&P 500.
S&P 500 performance during 3Q 2022
From the beginning of July through mid-August, the market had a substantial rally and there was some optimism that falling energy prices and moderating inflation could lead to a respite in the markets. But the fun was quickly extinguished during the 2nd half of the quarter.
Periods such as these can compound frustration for everyday investors. Just when you think the worst is past, the market crashes back down with a vengeance. Unfortunately, that is the nature of long-term investing. We must tolerate the short-term volatility in order to access the potential long-term benefits.
Also keep in mind that large market drops are normal:
Over the past 70 years, the stock market declined by 20%+ around every 6 years. And those declines tend to last about a full year before the recovery begins in earnest.
Again, staying focused on the long-term is critical. If you refer back to the first chart of this post, you’ll notice that even with the most recent market decline, U.S. stocks have returned around 10% over the past 10 years, which is a great result. Over long periods of time, day-to-day volatility tends to fade away and the long-term upwards trend in the stock market becomes more apparent.
Better forward-looking returns
Alongside this poor market performance, we are starting to see improved forecasts of future returns. Logically, this makes sense. If you can buy a productive asset at a discounted price, it stands to reason that you will see higher returns from that asset in the future.
To illustrate, here is a some data from Vanguard’s Market Perspectives report. Vanguard releases these reports every month and they provide a estimate of stock and bond market returns for the next 10 years.
Here are the changes between the May and September editions:
Although we saw a large drop in the markets between May and September, forward-looking returns have increased by about 2%. That may be cold comfort in the current market environment, but a 2% potential increase in future returns is no small benefit.
Economic Outlook
We live in strange times indeed. Ed Yardeni, a noted economist, recently stated, “Perversely, it’s going to take weak economic indicators to rally the market.” (emphasis mine)
The logic behind this sentiment goes something like this:
Stocks are trading down in large part due to increasing interest rates and the unwinding of “quantitative easing” policies by the Federal Reserve.
Only two things will stop the Fed’s current actions: a significant decrease in inflation, or a significant increase in economic pain.
It’s impossible to predict how the future will unfold, but for right now, the economy continues to fare well for the most part and inflation remains elevated. If either of those conditions changes, we could see the Fed move to pause or slow any future interest rate increases, which most experts believe will boost the market (at least in the near-term).
The Job Market
Here is look at the long-term history of U.S. unemployment:
As you can see, unemployment remains VERY low by historical standards. It’s pretty much as low as it’s ever been. Needless to say, the job market continues to favor employees looking for work.
Average hourly earnings growth (see below) also remains elevated between 5-6%. This is a far cry from the 2% growth that we experienced between 2010-2020.
Inflation
The Fed is fighting inflation in two ways: increasing interest rates, and shedding balance sheet assets.
Here is the Federal Funds Rate:
And the Fed’s balance sheet size:
While the Fed is working to get the job done, inflation remains stubborn:
Take a look at the most recent data points and you’ll notice that Core CPI (i.e. ex food and energy) increased, even as regular CPI decreased. This is a concerning data point. If inflation remains high even as food and energy prices moderate, that indicates that inflationary pressure is spreading into other sectors of the economy.
It’s tax planning season
Many people assume that tax planning occurs in the springtime when we gather all of our financial and tax documents and deliver them to the tax preparer so they can prepare and file our tax returns.
However, after January 1st rolls around most tax planning opportunities are no longer available.
The time for tax planning starts now. Between now and December 31st, you should calculate a pro-forma tax return for 2022. Start with your 2021 return if you have it handy and then adjust for any significant changes that occurred during 2022.
Add up all of your sources of income, adjustments, deductions, and any potential credits. Then start exploring various strategies to help manage your taxes.
The goal with tax planning is to minimize your lifetime tax bill, not just your tax bill in any single year. Many people (and their tax preparers) hate paying taxes, so they become hyper-focused on keeping their tax bill as low as possible each and every year. While there is value in deferring taxes, it’s often the case that recognizing some additional tax today could lead to an outsized tax benefit later on.
As you go through the tax planning process, it will be helpful to think about the following items:
Capital loss (or gain) harvesting
Charitable contributions or QCDs
Medical expenses
HSA contributions
Any remaining FSA funds
Tax benefits of 529 contributions
Any remaining RMD amounts
Roth conversions
Backdoor Roth contributions
Gifting to descendants
SEP IRA or solo-401(k) funding
This process can also help you prepare for 2023. If you are still working, review your current 401(k) contribution amounts and type (i.e. pre-tax, after-tax, or Roth) and be prepared to adjust them as needed. You can also review your quarterly tax payments or withholding amounts to make sure they match up with your potential 2023 income amounts.
Don’t forget open enrollment
Open enrollment for Medicare starts October 15th and for ACA plans on November 1st. If you get your health insurance through your employer, your enrollment season also likely starts soon.
Health insurance is a major (and growing) expense for many people, so be sure to review your options for coverage each year. Having the right health coverage can make a big difference in your finances, both now and in the future.
Matthew Jenkins is the Founder of Noble Hill Planning LLC. Matthew has over 15 years of experience working in both large and small financial services firms. Before starting his career in finance, Matthew served as a U.S. Army Ranger. Matthew values transparency and fair dealing and enjoys helping people prepare for a great retirement.
Market Commentary 3Q 2022
The 3rd quarter of 2022 offered another tough period for the financial markets. International stocks led the way down, falling by over 10% for the quarter. US stocks (both large and small) fared better, but were still down for the period. Bonds continued to suffer in the face of rising interest rates.
Here are the returns for the major asset classes during the quarter:
To add insult to injury, the stock market threw out a giant “head fake” for during the 3rd quarter. Take a look at the chart below of the S&P 500.
From the beginning of July through mid-August, the market had a substantial rally and there was some optimism that falling energy prices and moderating inflation could lead to a respite in the markets. But the fun was quickly extinguished during the 2nd half of the quarter.
Periods such as these can compound frustration for everyday investors. Just when you think the worst is past, the market crashes back down with a vengeance. Unfortunately, that is the nature of long-term investing. We must tolerate the short-term volatility in order to access the potential long-term benefits.
Also keep in mind that large market drops are normal:
Over the past 70 years, the stock market declined by 20%+ around every 6 years. And those declines tend to last about a full year before the recovery begins in earnest.
Again, staying focused on the long-term is critical. If you refer back to the first chart of this post, you’ll notice that even with the most recent market decline, U.S. stocks have returned around 10% over the past 10 years, which is a great result. Over long periods of time, day-to-day volatility tends to fade away and the long-term upwards trend in the stock market becomes more apparent.
Better forward-looking returns
Alongside this poor market performance, we are starting to see improved forecasts of future returns. Logically, this makes sense. If you can buy a productive asset at a discounted price, it stands to reason that you will see higher returns from that asset in the future.
To illustrate, here is a some data from Vanguard’s Market Perspectives report. Vanguard releases these reports every month and they provide a estimate of stock and bond market returns for the next 10 years.
Here are the changes between the May and September editions:
Although we saw a large drop in the markets between May and September, forward-looking returns have increased by about 2%. That may be cold comfort in the current market environment, but a 2% potential increase in future returns is no small benefit.
Economic Outlook
We live in strange times indeed. Ed Yardeni, a noted economist, recently stated, “Perversely, it’s going to take weak economic indicators to rally the market.” (emphasis mine)
The logic behind this sentiment goes something like this:
It’s impossible to predict how the future will unfold, but for right now, the economy continues to fare well for the most part and inflation remains elevated. If either of those conditions changes, we could see the Fed move to pause or slow any future interest rate increases, which most experts believe will boost the market (at least in the near-term).
The Job Market
Here is look at the long-term history of U.S. unemployment:
As you can see, unemployment remains VERY low by historical standards. It’s pretty much as low as it’s ever been. Needless to say, the job market continues to favor employees looking for work.
Average hourly earnings growth (see below) also remains elevated between 5-6%. This is a far cry from the 2% growth that we experienced between 2010-2020.
Inflation
The Fed is fighting inflation in two ways: increasing interest rates, and shedding balance sheet assets.
Here is the Federal Funds Rate:
And the Fed’s balance sheet size:
While the Fed is working to get the job done, inflation remains stubborn:
Take a look at the most recent data points and you’ll notice that Core CPI (i.e. ex food and energy) increased, even as regular CPI decreased. This is a concerning data point. If inflation remains high even as food and energy prices moderate, that indicates that inflationary pressure is spreading into other sectors of the economy.
It’s tax planning season
Many people assume that tax planning occurs in the springtime when we gather all of our financial and tax documents and deliver them to the tax preparer so they can prepare and file our tax returns.
However, after January 1st rolls around most tax planning opportunities are no longer available.
The time for tax planning starts now. Between now and December 31st, you should calculate a pro-forma tax return for 2022. Start with your 2021 return if you have it handy and then adjust for any significant changes that occurred during 2022.
Add up all of your sources of income, adjustments, deductions, and any potential credits. Then start exploring various strategies to help manage your taxes.
The goal with tax planning is to minimize your lifetime tax bill, not just your tax bill in any single year. Many people (and their tax preparers) hate paying taxes, so they become hyper-focused on keeping their tax bill as low as possible each and every year. While there is value in deferring taxes, it’s often the case that recognizing some additional tax today could lead to an outsized tax benefit later on.
As you go through the tax planning process, it will be helpful to think about the following items:
This process can also help you prepare for 2023. If you are still working, review your current 401(k) contribution amounts and type (i.e. pre-tax, after-tax, or Roth) and be prepared to adjust them as needed. You can also review your quarterly tax payments or withholding amounts to make sure they match up with your potential 2023 income amounts.
Don’t forget open enrollment
Open enrollment for Medicare starts October 15th and for ACA plans on November 1st. If you get your health insurance through your employer, your enrollment season also likely starts soon.
Health insurance is a major (and growing) expense for many people, so be sure to review your options for coverage each year. Having the right health coverage can make a big difference in your finances, both now and in the future.
Matthew P. Jenkins, CFA, CFP®
Matthew Jenkins is the Founder of Noble Hill Planning LLC. Matthew has over 15 years of experience working in both large and small financial services firms. Before starting his career in finance, Matthew served as a U.S. Army Ranger. Matthew values transparency and fair dealing and enjoys helping people prepare for a great retirement.
Matthew is a CFA® Charterholder and CERTIFIED FINANCIAL PLANNER™ Professional. He is also a member of the National Association of Personal Financial Advisors (NAPFA) and the Fee Only Network.