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Economic Risk Factor Update: May 2022

 
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Why Is the Market Going Down?

By  Brad McMillan, CFA, CAIA, MA I,   April 26, 2022
 
The economy seems to be doing well, with job growth still at high levels, consumer spending still healthy, and businesses continuing to invest. But the stock market—which is supposedly a barometer of that economy—is acting very differently. The market has fallen significantly from its peak at the start of the year and, more recently, has taken a sharper drop. What’s going on here, and will it continue?
 
All About Interest Rates
 
First of all, the stock market does not directly reflect the economy. There is a link, but what the stock market really tracks are two things: corporate earnings and interest rates. Earnings, of course, grow when the economy grows. So when interest rates are reasonably steady, the market does grow with the economy. Since that is most of the time, that is why we think the market tracks the economy.
 
Most of the time is not all of the time, however. We are now in one of the times when interest rates are not steady. Over the past couple of months, we have seen rates increase at one of the fastest paces in decades. Thus, even as the economy has done well and earnings continue to grow, those higher interest rates have acted as a headwind and pulled the price investors are willing to pay for those earnings down. It has been a difficult couple of months. And with the Fed publicly committed to continued interest rate hikes, the market clearly is pricing in more headwinds going forward.
 
Future Damage
 
But that fact also suggests that the future damage is likely to be limited. Markets already expect—and are pricing in—substantially higher rates. From here, any more damage has to come from interest rates moving even higher than the current substantial increases expected. At some point, that will not happen, as the factors driving those higher rates (i.e., growth and inflation) start to roll over.
 
We are seeing signs that growth is slowing, for example, and there is talk of a recession in the next year or two. Inflation pressures, while still very real, are starting to weaken as well. Just as markets are pricing in rate increases over the next year, they are also starting to price in rate decreases after that. Any decreases we see will act as a tailwind for stock prices at that time.
 
Valuation Levels
 
One way to evaluate where we are, and where we are going, is to look at overall valuation levels, which vary with interest rates. The chart below shows, for example, that between 2016 and 2019, before the pandemic, investors were willing to pay between 16 and 18 times the next year’s expected earnings for the S&P 500. After the start of the pandemic, when interest rates were cut sharply, that jumped up to 20 to 22 times earnings. Since the start of the year, however, as interest rates rose and the Fed committed to even higher rates, valuations dropped to between 18 and 20 times. That explains much of what has happened so far.
 
 
*Implied stock price index calculated using actual 52-week consensus expected forward earnings times hypothetical forward P/Es. Note: Shaded areas are recessions according to the National Bureau of Economic Research. Source: Standard & Poors and I/B/E/S data by Refinitiv.
 
What’s Next?
 
It also gives some guidance about what is coming next. Just as interest rates are expected to return to the pre-pandemic levels, so should valuations. That said, we could see another 10 percent downside, if valuations go back to the lower range of 16 times next year’s earnings. There could be more turbulence ahead in the short term.
 
Longer term, however, things look better. Earnings will keep growing over time, offsetting any decreases in valuation levels and eventually letting stock prices rise again. At some point—likely in the next year or two—rates will come down again, pushing valuations up. And at that point, we will see stock prices recover surprisingly quickly.
 
In other words, what we have seen is a typical, if sharper than usual, market cycle. In the short term, it is painful. But in the longer term? It really doesn’t mean much. As long as the economy is basically healthy (which it is) and as long as policymakers are on top of things (which they are), companies will keep growing and making money. We, as investors, will be able to profit from that.
 
So, Why Is the Market Going Down?
 
Because the Fed is raising rates to get inflation under control. This is painful in the short term, but necessary to lay the foundation for future growth. As always, we just need to ride out the short-term pain to benefit from that future growth.
 
Keep calm and carry on.
 
© 2022 Commonwealth Financial Network®
 
© Axial Financial Group. All Rights reserved. 5 Burlington Woods, Suite 102 Burlington, Massachusetts
 
Disclosure: Certain sections of this commentary contain forward-looking statements based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets. All indices are unmanaged and investors cannot invest directly into an index. The Dow Jones Industrial Average is a price-weighted average of 30 actively traded blue-chip stocks. The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. The Nasdaq Composite Index measures the performance of all issues listed in the Nasdaq Stock Market, except for rights, warrants, units, and convertible debentures. The MSCI EAFE Index is a float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a market capitalization-weighted index composed of companies representative of the market structure of 26 emerging market countries in Europe, Latin America, and the Pacific Basin. It excludes closed markets and those shares in otherwise free markets that are not purchasable by foreigners. The Bloomberg Barclays Aggregate Bond Index is an unmanaged market value-weighted index representing securities that are SEC-registered, taxable, and dollar-denominated. It covers the U.S. investment-grade fixed-rate bond market, with index components for a combination of the Bloomberg Barclays government and corporate securities, mortgage-backed pass-through securities, and asset-backed securities. The Bloomberg Barclays U.S. Corporate High Yield Index covers the USD-denominated, non-investment-grade, fixed-rate, taxable corporate bond market. Securities are classified as high-yield if the middle rating of Moody’s, Fitch, and S&P is Ba1/BB+/BB+ or below.
 
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Will The Housing Market Crash? Experts Give 5-Year Predictions

Published by Natalie Campisi and Rachel Witkowski

Presented by Axial Financial Group

Forbes Advisor Staff,   Editors, Apr 4, 2022
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4 Steps To Help Your Kids Build Smart Money Habits

Authored by Ashlea Ebeling Senior Contributor, Forbes, April 5, 2022

Presented by Axial Financial Group

 

1. HELP KIDS LEARN WITH REAL MONEY

Giving your kids a reasonable allowance—as opposed to simply buying them things they want—is a good thing. “It creates agency and responsibility,” Ziv says. “It also gives them freedom to make mistakes at a lower-stakes level. We’re all going to make mistakes. It’s better to make them early on where there are parental guardrails.” If your teen is earning money on their own, consider a “parental match”—similar to an employer match into a 401(k)—to encourage saving. The match can be into a regular savings or investing account, a 529 college savings account or a Roth Individual Retirement Account kids can open in their own names. You can help fund the Roth up to your child’s earned income. And don’t be put off by the name of the account; contributions to a Roth grow tax-free for retirement but can be withdrawn without penalty should your child need them for college, a house or any other goal along the way. If your child gets a W2 tax form showing their earned income, that’s the time to discuss gross and take-home pay—and taxes. The good news is they may be due a tax refund if they were a regular employee and taxes were withheld. The bad news is if they earned more than $400 in gig income from odd jobs like babysitting, tutoring or lawn mowing, they are required to file a tax return and may owe Uncle Sam some money.

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Weekly Market Update, March 21, 2022

Presented by The Axial Company       

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Weekly Market Update, August 24, 2020

Presented by The Axial Company       

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Weekly Market Update, August 17, 2020

Presented by The Axial Company       

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Weekly Market Update, August 10, 2020

Presented by The Axial Company       

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Weekly Market Update, July 20, 2020

Presented by The Axial Company       

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Weekly Market Update, July 13, 2020

Presented by The Axial Company       

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Weekly Market Update, June 1, 2020

Weekly Market Update, June 1, 2020

Presented by The Axial Company                        

General Market News              

  • The 10-year Treasury yield opened at 0.66 percent on Monday, while the 2-year came in at 0.17 percent and the 30-year at 1.43 percent. We are set to get some May economic numbers this week, which should give us a clearer view on where we stand as an economy. The Federal Reserve meets next week, and, while it has done a lot and has essentially asked Congress to step in, it should be interesting to see what members have to say when faced with hard May economic numbers.
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Weekly Market Update, March 9, 2020

Presented by The Axial Company                                                                     

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Weekly Market Update, March 2, 2020

Presented by The Axial Company                                                                     

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Weekly Market Update, February 24, 2020

Presented by The Axial Company                                                                     

General Market News              

  • Rates continued to fall last week, as concerns about the spread of the coronavirus rattled global markets. The 10-year Treasury yield opened at 1.38 percent, nearing lows last seen in 2016. The 30-year fell to 1.83 percent, which is its all-time low.
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Weekly Market Update, February 18, 2020

Presented by The Axial Company                                                                     

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Weekly Market Update, February 10, 2020

Presented by The Axial Company                                                                     

Weekly Market Update, February 10, 2020

General Market News              

  • Global health concerns have led to heightened uncertainty in the economy and markets over the past couple of weeks. The 10-year Treasury yield has bounced around from 1.90 percent, to 1.50 percent, to 1.70 percent, and now back to 1.56 percent as of Monday morning. The 30-year yield is back at more than 2 percent, and the short end of the curve remains slightly inverted, with the 2-year yield at 1.38 percent and the 3-year yield at 1.36 percent.
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Weekly Market Update, February 3, 2020

Presented by The Axial Company                                                                     

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Weekly Market Update, January 28, 2020

Presented by The Axial Company                                                                     

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Weekly Market Update, January 21, 2020

Presented by The Axial Company                                                                     

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Weekly Market Update, January 13, 2020

Presented by The Axial Company                                  

General Market News              

  • The bond markets experienced more volatility last week. The 10-year Treasury yield was as low as 1.70 percent and as high as 1.90 percent as a result of news from Iran. It opened at 1.83 percent on Monday. The 30-year bounced between 2.19 percent and 2.38 percent before opening at 2.29 percent. The 2-year, which is usually more stable given its shorter duration, swung between 1.44 percent and 1.61 percent.
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