Roughly 90 days ago, Ratio Wealth Group sent our quarterly letter framing the crosscurrents of economic and financial data. The equity and bond markets were wrestling with rampant inflation, recessionary fears, a hawkish Federal Reserve, and geopolitical unrest. The result was a volatile first half of 2022 as investors grappled with market fundamentals and the right price to pay for what was becoming altered growth.
Economic data around inflation beginning to soften and the consumer maintaining general health, allowed for equities to start the quarter with double digit gains through mid- August. Bonds stabilized and there appeared to be a collective pause around volatility. Levelheadedness seemed to emerge with a telegraphed Federal Reserve and directional improvement around employment, consumer spending and industrial production.
Selling pressure reemerged in the back half of August and through September as Fed Chair, Jerome Powell, inflation control was the key objective. Investors defaulted to the rise in bonds and equities as nothing more than a bear market rally.
As we begin the fourth quarter, the markets are essentially where they were three months ago with the same concerns we highlighted in our last communication. While equity multiples have contracted over 25% for the year, earnings estimates have not followed, which means that investors do not believe corporations will be able to weather potential slower sales and higher input costs. Company earnings reports in the coming weeks will give us some clarity to the forecasted strength or weakness on the horizon. Market gyrations leading to now are a result of the spread of expectations. Once the known level of adjustments is understood, the markets can begin to find a foundation for asset price improvement. We forecast
will begin to show directional impact. At some point, economic bad news becomes good news for the markets.
With respect to a recession, we recognize a slowing must occur in the face of rate increases as dramatic as we have seen. The Federal Reserve raises rates to make the cost of borrowing higher, which in theory slows purchasing and thus tempers inflation. The loans and variable debt like a home equity line of credit. However, the strength of the consumer with low unemployment, modest wage increases, and overall low household debt service ratios can continue to buoy an economy (GDP) that is ~70% consumer driven. More succinctly, if a technical recession is in the cards, we do not believe a deep, prolonged slowdown is an accurate outcome. With that backdrop, equity price declines like we have seen can be disconnected with the intrinsic value of a company. For long- term investors, here is where opportunity lies and where we are making strategic cash adds to investment accounts.
We are continuing the tax-loss harvesting done in taxable accounts and strengthening exposure towards global value and dividend paying equities. Execution on this thesis continued over the last three months and we have confidence in portfolio allocations as we head towards 2023. With respect to the bond market, yields have obviously improved year-to-date. For appropriate accounts, strategic short-term ladders are being created. While relative yields are better in the fixed income markets, real returns when we overlay inflation still make bonds an underweight vs. equity exposure. We continue to analyze longer-term bond yields with an eye on opportunistic entry points.
