as of September 30, 2022
It was another difficult quarter for both stocks and bonds as global markets continued their downtrend in the third quarter. Federal Reserve Chair Powell’s speech at Jackson Hole in August dashed hopes that the Fed would consider pausing its tightening cycle. After recovering in July, both equity and bond markets broke through June lows. As a result of hawkish Fed guidance, bond markets ratcheted up expectations for this cycle’s terminal interest rate from 3.25% at the end of July to 4.5%. The drawdown in stocks and bonds this year appears to be a reasonable response to the shift in Fed policy to combat inflation and the resulting uncertainty for economic growth. The decline in equities can be explained by the rise in interest rates putting downward pressure on valuations. The outlook for inflation and its impact on Fed policy likely will remain the key driver of the markets’ direction.
Encouragingly, inflationary pressures appear to be easing. The decline in energy prices in the US from their peaks should lead the headline inflation rate lower in the coming months. The gradual easing of supply side constraints and weaker demand could also slow core inflation. Easing inflation could mean that Fed hawkishness is near the peak. US economic activity has been nearly flat in 2022 and the tightening of financial conditions is only just beginning to be felt. The drag likely will intensify into 2023, increasing the risk of at least a mild recession. The good news is that household balance sheets remain strong, which should cushion household spending and prevent a deep downturn.
Global equities posted another quarter of declines in Q3, with the MSCI ACWI index, a measure of global equities, falling 6.8% during the quarter. Year-to-date, the index has declined 27.1%. The S&P 500 fell 4.9% during the quarter, and is now down 23.9% year-to-date. International developed stocks declined 9.4% in Q3, leaving their year-to-date decline at 23.9%. A stronger dollar detracted 5.8% from US dollar returns during the quarter. Emerging market equities fell 11.6% in Q3 and 27.2% year-to-date.
Within fixed income, interest rates continued to weigh on returns. The Bloomberg Aggregate index declined 4.8% during the quarter. Treasuries declined 4.3%, but outperformed corporate bonds, which declined 5.1%. The yield curve shifted higher and flattened, with 3-month yields rising 161 basis points, while 30-year yields rose by 65 basis points.
Real estate investment trusts (REITs) fell roughly 11% during Q3, faring worse than broader equity markets. Infrastructure stocks declined 9% during the quarter, but they have outperformed broader markets year-to-date. Commodities and natural resource stocks posted modest declines during the month on fears of a global slowdown, but returns remain positive year-to-date.
Looking ahead, a mild recession that reduces inflation could prove supportive of both stock and bond markets. The prospect of the Fed halting rate increases and a fall in longer-term interest rates could more than offset the negative impact of weak earnings for equities in a mild recession. The biggest downside risk we see is if inflation remains sticky even as the economy slows. This could require a more forceful Fed response and a deeper recession. This likely would result in continued weakness in stocks and bonds.
Important notices
References to Mercer shall be construed to include Mercer LLC and/or its associated companies.
© 2022 Mercer LLC. All rights reserved.
This contains confidential and proprietary information of Mercer and is intended for the exclusive use of the parties to whom it was provided by Mercer. Its content may not be modified, sold or otherwise provided, in whole or in part, to any other person or entity without Mercer’s prior written permission.
Mercer does not provide tax or legal advice. You should contact your tax advisor, accountant and/or attorney before making any decisions with tax or legal implications.
This does not constitute an offer to purchase or sell any securities.
The findings, ratings and/or opinions expressed herein are the intellectual property of Mercer and are subject to change without notice. They are not intended to convey any guarantees as to the future performance of the investment products, asset classes or capital markets discussed.
For Mercer’s conflict of interest disclosures, contact your Mercer representative or see www.mercer.com/conflictsofinterest. This does not contain investment advice relating to your particular circumstances. No investment decision should be made based on this information without first obtaining appropriate professional advice and considering your circumstances. Mercer provides recommendations based on a client’s particular circumstances, investment objectives and needs. As such, investment results will vary and actual results may differ materially.
Information contained herein may have been obtained from a range of third party sources. While the information is believed to be reliable, Mercer has not sought to verify it independently. As such, Mercer makes no representations or warranties as to the accuracy of the information presented and takes no responsibility or liability (including for indirect, consequential, or incidental damages) for any error, omission or inaccuracy in the data supplied by any third party.
Past performance is no guarantee of future results. The value of investments can go down as well as up, and you may not get back the amount you have invested. Investments denominated in a foreign currency will fluctuate with the value of the currency. Certain investments, such as securities issued by small capitalization, foreign and emerging market issuers, real property, and illiquid, leveraged or high-yield funds, carry additional risks that should be considered before choosing an investment manager or making an investment decision.
Investment management and advisory services for U.S. clients are provided by Mercer Investments LLC (Mercer Investments). In November, 2018, Mercer Investments acquired Summit Strategies Group, Inc. (“Summit”), and effective March 29, 2019, Mercer Investment Consulting LLC (“MIC”), Pavilion Advisory Group, Inc. (“PAG”), and Pavilion Alternatives Group LLC (“PALTS”) combined with Mercer Investments. Certain historical information contained herein may reflect the experiences of MIC, PAG, PALTS, or Summit operating as separate entities. Mercer Investments is a federally registered investment adviser under the Investment Advisers Act of 1940, as amended. Registration as an investment adviser does not imply a certain level of skill or training. The oral and written communications of an adviser provide you with information about which you determine to hire or retain an adviser. Mercer Investments’ Form ADV Part 2A & 2B can be obtained by written request directed to: Compliance Department, Mercer Investments, 99 High Street, Boston, MA 02110.