For investors, the third quarter began with a relief rally, but ended again in a doldrums.
It was an especially tough quarter for the already blood-soaked bond market, where many bond mutual funds are posting their worst losses ever.
The result is that even investors with portfolios diversified between stocks and bonds, through what is often known on Wall Street as the 60/40 portfolio approach, face losses of close to 20% this year. In fact, in the third quarter, the performance of a 60/40 portfolio would have been worse than that of a majority investment in stocks, an extremely unusual turn of events.
Stock and bond market performance, along with increasingly extreme moves in currency markets, continued to be driven by the fallout from decades of high inflation, aggressive interest rate hikes by the Federal Reserve and others. major central banks, rising risks of recession, and lingering ripples from the pandemic and the Russian invasion of Ukraine.
At the end of the quarter, stocks were solidly in bear market territory and bond yields, which move in the opposite direction of prices, were at their highest levels in years.
However, it didn’t start that way. A stock market rally that began late in the second quarter sent Morningstar’s US market index up more than 18% from its low point in mid-June. Bond yields fell amid hopes that inflation had passed its peak and that the Fed might ease its aggressive interest rate hikes.
But a surprisingly high inflation reading for August caused concern for investors and Fed officials alike. At the last policy meeting on September 20, Chairman Jerome Powell and the Fed board signaled more rate hikes. for the rest of the year, sending bonds and stocks into a deep sell-off that lasted until the last days of the quarter.
Key Statistics: Third Quarter Market Performance
- The Morningstar US market index lost 4.6% during the third quarter. The stock hit a new bear market low on the last day of the quarter, down 24.9% so far in 2022. That’s its worst performance to this point in any year since 2002.
- It was a dramatic round trip for the stock market’s performance in the third quarter. Morningstar’s US market index rose 14.6% from the end of June to August 16, then fell 16.5% from that high at the end of the third quarter.
- Morningstar’s US market index has fallen for three straight quarters, the kind of losses not seen since 2008.
- Dividend stocks took a hit, falling 5.6% as a group, lagging the broader market by a full percentage point.
- Bonds are having their worst year in modern history, as the Morningstar US Core Bond Index fell 14.6% in the year to September 30.
- The yield on two-year US Treasuries soared higher, ending the quarter at 4.22%, up from just 0.27% a year ago. Before September, two-year yields had not been this high since October 2007.
- The yield curve is now significantly inverted, marking a commonly cited indicator of an impending recession. The last time the yield curve inverted was in 2019. Now, it is the most inverted since the summer of 2000.
- The Fed’s hard-line effort to stamp out inflation prompted two more aggressive rate hikes, raising the effective federal funds rate target to 3.00%-3.25%, its highest level since 2008.
- The US dollar is at its best in two decades, adding to concerns about the outlook for corporate profits.
- Crude oil prices hit their lowest levels since January, ending the quarter at $77.1/barrel.
Best and worst performance in the market
At the end of the third quarter, economically sensitive markets were among those that suffered the biggest losses as investors remained concerned about the possibility of a global recession amid a sharp rise in interest rates.
The Morningstar US REIT Index, which represents publicly traded real estate investment trusts, and the Morningstar 10+ Year Treasury Bond Index, both sensitive to changes in interest rates, each fell 10% this quarter.
Morningstar UK’s core bond index had its worst quarter as sterling fell to an all-time low against the dollar. The pound’s value fell sharply as a new UK government unveiled plans to grow the country’s economy through a combination of tax cuts and heavy government borrowing at a time when inflation is already a challenge.
While the third quarter saw a poor performance for emerging market investments overall, some countries bucked the trend. Among Morningstar’s country indices, Morningstar’s Turkey index was the best performer as the country’s central bank continued to lower interest rates despite 80% inflation. The Morningstar indices for Brazil and India posted positive gains in the negative quarter.
Stock Market Performance
By the end of the third quarter, stocks were back in bear market territory, erasing a rebound that began in the closing weeks of the second quarter.
Although the third quarter had a sour ending, the performance of the stock market had started on a positive note. In July, Morningstar’s US market index rose 9.4% for its best monthly performance since November 2020. Stocks continued to rally through the first half of August, reaching a high point on August 16 . That rally sent the stock up 14.5% in the quarter. , recovering more than half of the losses suffered by the market until mid-June. The strong move higher, coupled with expectations that inflation had peaked, had investors wondering if the worst was over and if stocks had started a new bull run.
But it was not like that.
Inflation continued to rise, and in September, a third consecutive aggressive interest rate hike by the Federal Reserve and growing recession fears caused another drop in stocks. An earnings warning from global shipping company FedEx FDX added to concerns about the impact of the slowing global economy on corporate profits, which have remained stronger than many expected.
Morningstar’s US market index hit a new bear market low on the quarter-end closing day on September 30, as investors resigned themselves to continued volatility and the potential for a prolonged bear market, rather than of the V-shaped rebounds that have occurred afterwards. recent recessions.
At the end of the third quarter, the shares fell 4.6% over the previous three months and 24.9% so far in 2022.
Value Stock vs. Growth Stock Yield
It’s been a brutal year for investors in growth stocks, but at least in the third quarter those losses didn’t get much worse.
For much of the quarter, there was no clear winner in the value growth tug-of-war: Some in the markets recommended switching to beta—a measure of volatility— to find the next leaders amid an uncertain landscape. But in the closing days of the third quarter, growth and combined stocks outperformed their value counterparts.
In fact, at the end of the third quarter, value stock losses exceeded those of growth stocks, a reversal of the previous quarter, when value outpaced growth by the widest margin since the collapse of the dot-com bubble.
Still, high-growth stocks are on track for their worst year since 2008.
The strengthened dollar
The Fed’s rate hikes have also caused significant ripples in currency markets, with the US dollar rising to multi-decade highs against major currencies.
The dollar is having its best race in 20 years. With US interest rates rising rapidly and investors concerned about a global economic slowdown, investors have flocked to the US currency in search of yield and a safe haven. The dollar rose 8.6% during the quarter. Meanwhile, the euro fell 6.8% against the dollar and the yen fell 15.2%.
The strengthening of the US dollar will probably have a negative effect on third quarter earnings, according to Morningstar chief market strategist David Sekera. Large multinational technology companies in particular will see a headwind as a sizeable portion of their sales come from outside the United States. That’s because as the value of the dollar rises, it makes goods produced in the US more expensive outside the country.
Key commodities fell during the third quarter, with the notable exception of wheat prices, which rose 10.9% in the period, as global wheat supply continues to be affected by Russia’s aggression in Ukraine.
Despite gold’s long history as a safe havenAs Amy Arnott, portfolio strategist at Morningstar, writes, its ability to improve portfolio performance over longer periods has been compelling. This quarter, the asset class sizzled and fell into negative territory with losses of 8.2%.
Copper also ended the third quarter in the red, although its decline was moderate compared to a sharp 21% drop in the second quarter. The metal is seen as an indicator of the global economy, as it is used as an input in production and equipment for a wide range of industries.
Cryptocurrency investors also continued to suffer from the volatility. However, for bitcoin, the first cryptocurrency and the largest by market size, the changes were much more moderate than they have been, especially compared to the second quarter when it lost 57% of its value.
Bitcoin started trading on July 1 at $19,820 and closed on September 30 at $19,431.
The second largest cryptocurrency, ether, ended the quarter in positive territory but far from its best levels of the previous three months.
What’s next for stock and bond market performance?
From here, the outlook will depend almost entirely on the pace at which inflation starts to decline, market strategists and fund managers say.
Unless inflation begins to decline rapidly, the pressure on the stock and bond markets is not likely to ease any time soon. For now, more signs point to a slowdown in economic growth and the Fed is preparing for two more interest rate hikes before the end of 2022.
In that context, investors should keep their seat belts fastened and prepare for even more volatility and difficult market performance in the coming months.
Note: This article was originally published for a US audience.