In January 2022, Fed Chairman, Jerome Powell, acknowledged that the Federal Open Market Committee (FOMC) was behind in addressing inflation. Therefore, they set a plan to tackle inflation by raising interest rates eight quarter-points or 2.0% in the year 2022. By July of this year, the Fed had exceeded its original target, raising interest rates nine quarter points by mid-year. In an over-simplified cause-and-effect analysis, raising interest rates tends to slow economic growth, as the cost to borrow increases, and therefore, spending decreases. The Fed hoped that decreased spending would bring balance back to the supply and demand relationship and ultimately decrease inflation. As a result of the Fed’s 2022 policies, the U.S. experienced two successive quarters of negative growth in the first and second quarter of 2022, as measured by Gross Domestic Product (GDP). Enduring the downturn was painful. By June of 2022, the widely quoted Dow Jones Industrial Average was down 18% and the broader S&P 500 was down 24% year-to-date.
However, many welcomed the Fed reaching its interest rate increase goal by mid-year. Investors were optimistic that they had suffered the worst, and better days were ahead. This led to a summer rally and from mid-June to mid-August, the Dow jumped 14% and the S&P 500 increased 17%.[i] It is interesting to say that we almost reached a bull market rally in the middle of a debatable “economic recession.” Anyhow, our summer glory was cut short when the Fed concluded their Jackson Hole, Wyoming meeting at the end of August. Fed Chairman Jerome Powell announced a shift in messaging and the stock market fell.
Prior the Fed stated they were looking to execute a, “soft landing,” meaning they hoped to find a balance between curbing inflation and impeding economic growth. However, in his most recent speech, the Chairman was purposefully more direct. He stated that “reducing inflation is likely to require a sustained period of below-trend growth.” Further, he noted that doing so would, “bring some pain to households and businesses, [but] these are the unfortunate costs of reducing inflation.”[ii]
Understandably, the market was not pleased and much of our summer rally dissipated. Many question what the road ahead looks like. While it is hard to speculate, the consensus is a longer recovery period than originally anticipated, and a rocky road to recovery. The Fed appears to have sacrificed the “soft landing” goal for expedited reduction of inflation. Their goal and the priority both make sense. Inflation often disproportionately affects lower income households, who cannot bear the burden of rising costs. Food, gas, and energy were at extraordinarily high prices, with the 9% year-over-year increase in inflation as measured by the Consumer Price Index (CPI), experienced this summer.[iii] Corrective measures may come at the cost of temporary decreases in the stock market, but Powell warned that the failure to restore price stability would lead to far greater pain in the long run.
The Fed noted that another unusually large interest rate increase of 0.75% could be an appropriate next step at the September 2022 meeting. However, the final increase in interest rates will depend on the economic and inflationary data that materializes, as August month-end numbers are finalized.
Aside from the stock market, the movement in interest rates has also significantly affected the housing market. Mortgage rates have nearly doubled in the first half of 2022. Census data showed that new home sales were down 30% in 2022, compared to the year prior. That is important as home purchases and related spending accounts for as much as 18% of GDP, and the housing sector typically leads recoveries.[iv] American homeowners may need to be mentally prepared, as the housing market may disproportionately bear the brunt of disinflation in the year to come.
On the flip side, boom and bust markets each present investment opportunities that should not be overlooked. Anyone experiencing large loss positions in their investment portfolio may want to realize or harvest losses to offset against taxable gains on their tax returns. Those who have accumulated cash on the sidelines with a minimum investment life of 18 months may want to consider getting back into the market. While many investors were exuberant to buy in 2021 at market highs, the more valuable time to enter the market is actually when the market is down and stocks are on “sale.” Buying when the market is down allows for the rebound or growth to occur inside of your stock portfolio. Households who can afford to pay extra income taxes may want to shift or convert funds from pre-tax IRAs to after-tax Roth IRAs. This strategy triggers taxable income to the IRA owner at the time of conversion, but it allows investment recovery to happen in a tax-free account, making any gain tax-free. Finally, rebalancing an investment portfolio to your pre-set asset allocation target can help ensure you are locking in gains when the market is high and buying stocks when they are priced low, in a systematic way that takes the emotional stress out of your decision-making.
Whatever lays ahead, there is some peace in feeling prepared and knowing that hard work now may lead to better days ahead. Reach out to a Certified Financial Planner™ if a second option could strengthen your plan for the rocky road ahead!
[iii] U.S. Bureau of Labor Statistics, tradingeconomics.com