Be prepared as rates are going up more in 2022 and likely in 2023 too

A few days before the beginning of August 2022, Wall Street’s eyes and ears were on the Federal Reserve, and as expected, the FOMC raised the fed funds rate by 75 basis-points. It was the Fed’s second consecutive 75 basis-point increase, taking its benchmark rate to a range of 2.25%-2.5%.

But what was surprising, at least to some, was that the Fed seemed to signal that the pace of rate hikes might slow down in 2022, as Fed Chair Jerome Powell said there will be a point where the Fed starts to slow hikes to assess their impact.

As an investor, you undoubtedly ask when, or if, the Federal Reserve Bank raises interest rates, how will that affect consumers and businesses? In particular, what about the consequences for certain segments of the economy?

Reason for the Fed’s Change

The most important tool available to the Fed is its ability to set the federal funds rate, or the prime interest rate. This is the interest paid by banks to borrow money from the Federal Reserve Bank. Interest is, basically, the cost to the banks of borrowing someone else’s money. The banks will pass on this cost to their own borrowers.
As a way to boost the economy, remember that the Fed set its benchmark interest rate close to zero in late 2008 and did the same thing at the beginning of the COVID pandemic. This resulted in “free money.”

By reducing the federal funds rate, the Fed increased the supply of money by making it less expensive to obtain. As a result, businesses could have greater access to money. They could spend more on building their businesses and on hiring more employees. Because consumers and businesses had more money, they could purchase more goods, services, houses, and stocks.

Increasing the federal funds rate, on the other hand, reduces the supply of money by making it more expensive to obtain. Reducing the amount of money in circulation, by decreasing consumer and business spending, helps to reduce inflation. However, the Federal Reserve has to decide whether the increase in consumer demand and in hiring has led to enough inflation in prices to warrant a reduction in rates.

Consequences for Consumers and Businesses

Any increased expense for the banks to borrow money has a ripple effect, which influences both individuals and businesses in their costs and plans.

Effect on individuals – Banks increase the rates that they charge to individuals to borrow money, through increases to credit card and mortgage interest rates. As a result, consumers have less money to spend. They must face the effect on what they want to purchase and when to do so.

Effect on business – Because consumers have less disposable income, businesses must consider the effects to their revenues and profits. Businesses also face the effect of the greater expenses of borrowing money. As the banks make borrowing more expensive for businesses, companies are likely to reduce their spending. Less business spending and capital investment can slow the growth of the economy, decreasing business profits.

These broad interactions can play out in numerous ways.

Special Effects

The stock market as a whole – Stock prices decrease when investors see companies reduce growth spending or make less profit. Absent other economic effects, the value of stocks in general will fall.

Bond market – As the stock market drops, investors tend to view the risk of stock investments as outweighing the rewards. They will often move toward the safer bonds and Treasury bills. As a result, bond interest rates will generally rise, and investors will likely earn more from bonds.

The dollar – When other central banks are expanding the money supply, it weakens the value of their currencies. If the Fed hikes the interest rate, then the dollar appreciates. A stronger dollar means that U.S. consumers pay less for imports. A stronger dollar will boost U.S. demand for products from Asia and Europe, which will increase corporate profits there. As a result, global stocks will likely increase in value.

Commodity prices – A stronger dollar has often contributed to the reduction in oil prices in the past year. As the dollar could become even stronger with the reduction of interest rates, the prices of commodities, especially oil, should decrease. And often the opposite is true. Of course, investments in oil stocks will likely also lose some value.

The federal budget – The U.S. government has a very large debt, and increased interest rates lead to higher interest payments.

Corporate borrowers – Companies that are repaying loans will end up with higher interest payments.

Mortgage holders – Payments on mortgage interest will increase for individuals and companies whose mortgages do not carry a fixed interest rate.

Obviously, many factors affect activity in various parts of the economy. A change in interest rates, although important, is just one of those factors.

The Fed’s Next Timing

The Federal Open Market Committee, which sets the rates, will meet again three more times before next year, starting on:

• September 20-21
• November 1-2
• December 13-14

While there are expectations that more rate hikes are coming in 2022, circle these dates on your calendar and expect to hear lots of chatter.

And while many factors can affect the market, it is important to prepare for any effects on your business, your livelihood, and your investment portfolio when an increase in the federal funds rate does take place.

Be sure to talk to your financial advisor for specific guidance.

Copyright © 2022 FMeX.

Many parents may feel it is unnecessary to inform their adult children about their personal, financial affairs. However, as your children grow older, it can work to your advantage—and that of your entire family— to share with them key financial, medical, and estate planning information. An awareness of important information, and knowing where to locate relevant documents, can help your grown children take appropriate and timely action if a sudden death or catastrophic illness were to occur. Consider these issues:

• Health Insurance. If you are age 65 or over, your adult children should be aware of any and all health insurance policies, as well as Medicare materials. There may be “Medigap” policies that go beyond the basic care coverage provided by disability income insurance policies and long-term care (LTC) policies. You may benefit greatly in an emergency if appropriate procedures are followed and necessary forms are submitted in a timely manner.

• Living Will. This document specifies an individual’s preferences regarding the administering or withholding of life-sustaining medical treatment. Under many state statutes, a patient must be considered “terminal,” “permanently unconscious,” or in a “persistent vegetative state” before life support can be withdrawn. Copies of living wills should be made available to anyone who would be involved with the care of either parent, and the originals should be kept in a safe, readily accessible storage place.

• Health Care Proxy. Similar to a living will, this instrument allows you to appoint another person as your “agent” to make health care decisions in the event you become incapacitated and unable to make your own decisions. Specific directions regarding medical procedures to be administered, withheld, or withdrawn can be made within the document. A copy should be readily available to the “agent.”

• Durable Power of Attorney for Property. If you become disabled, who will manage your financial affairs? With a durable power of attorney in place, an individual or bank may act as an agent to oversee your financial affairs. Your grown children should know what steps have been taken to ensure the competent direction of your affairs, should the need arise. However, your children’s actual involvement with your affairs can be limited, if so desired.

• Wills. Do they exist and are they up-to-date? The exact contents can be kept private, but the location of your will should be known by all family members.

• Trusts. Wills can accomplish much in the direction of your estate after your death. However, a trust managed by yourself, or a trustee of your choosing, may meet your planning needs, including potentially protecting the estate from taxation. Trust documents should be kept with wills for ease of access, and you should discuss pertinent terms with those who will be involved. As your children reach adult age, it may be time to select a responsible child to serve as a trustee in the event of your death.

• Life Insurance. Life insurance is typically purchased to provide cash to help cover mortgages, liabilities, expenses, and estate taxes, as well as to benefit your loved ones. Knowledge of the existence and whereabouts of life insurance policies can be of critical importance. A policy locked in the deceased’s safe deposit box cannot accomplish the aims for which it was intended.

EPOC154-X

• List of Assets and Debts. Once again, adult children may know of the existence of lists of assets and debts without seeing the actual lists themselves, unless you so desire. An asset list—developed and updated regularly—should include information concerning all bank accounts, real estate holdings, pension holdings, annuities, business agreements, brokerage accounts, documentation concerning boats, cars, works of art or other valuables, and collectibles, and insurance policies. A debt list should include information pertaining to current mortgages, consumer indebtedness, personal loans, and business obligations. Both lists should provide complete information on where associated paperwork and files can be found.

Planning for death or disability can be difficult. However, leaving your grown children uninformed about your key financial, medical, and estate planning information can result in confusion and delay at a time when clarity and timeliness are of the essence. At first glance, these preparations may seem burdensome. However, once completed, both you and your children can rest assured that your affairs will be properly managed if needed.

Copyright © 2022 FMeX.

Markets Have Terrible Second Quarter

Global equity markets had an awful second quarter and when the final Wall Street-bell weakly tolled on June 30th, all major global equity markets were in the red, leading to overall market declines not seen in decades.

To underscore how bad it has been so far in 2022, consider that the S&P 500 recorded its worst first six months in 52 years and the DJIA recorded its worst first six months since 1962.

For the second quarter of 2022:

• The DJIA dropped 11.2%;
• The S&P 500 lost 16.7%;
• NASDAQ plummeted 22.7%; and
• The Russell 2000 declined 18.4%.

The themes that drove market performance in the second quarter were the same worries that drove markets in the first quarter and towards the end of last year. And the two most dominant themes continue to be inflation and the Fed with the former rising to 40-year highs and the latter causing Wall Street to worry that the course of rising rates would lead to a recession.

The other themes were plummeting consumer confidence, rising food and gas prices, negative GDP numbers, declining manufacturing, a cooling-off of the housing market, not-so-wonderful corporate earnings, continued supply-chain bottlenecks and a lot of social unrest here at home.

Further, we saw that:

• Volatility, as measured by the VIX, trended up significantly this quarter, beginning the quarter around 19 and ending the month just south of 29.
• West Texas Intermediate crude trended up slightly for the quarter, starting at just under $100/barrel and ending the quarter at over $105. For perspective, WTI started 2022 at about $75/barrel.

Market Performance Around the World

Investors were unhappy with the quarterly performance around the world, as all 36 developed markets tracked by MSCI were negative for the second quarter of 2022 – and all of them saw negative returns in the double digits. And for the 40 developing markets tracked by MSCI, 39 of them were negative too, with many losing more than a quarter of their value.

Index Return	2Q2022
MSCI EAFE	-15.37%
MSCI EURO	-17.33%
MSCI FAR EAST	-13.63%
MSCI G7 INDEX	-16.70%
MSCI NORTH AMERICA	-17.07%
MSCI PACIFIC	-14.81%
MSCI PACIFIC EX-JAPAN	-14.84%
MSCI WORLD	-16.60%
MSCI WORLD EX-USA	-15.47%

This Bear Seems Especially Angry

U.S. equity markets turned in a terrible second quarter to add to a not-so-great first quarter, pushing the major equity markets to levels not seen in a long time. And while many are suggesting that there is more pain to come from this bear, there are also plenty of others suggesting that the worst is behind us. But we of course won’t know for sure for another six months.

For the YTD through the end of June::

• The DJIA is down 15.9%;
• The S&P 500 is down 21.0%;
• NASDAQ is down 30.3%; and
• The Russell 2000 is down 24.8%.

Sector Performance Rotated in 2Q2022

The overall trend for sector performance for the second quarter and the YTD was ugly, as all 11 S&P 500 sectors dropped for the second quarter and only the Energy sector is positive YTD. As if those numbers weren’t bad enough, the performance leaders and laggards rotated throughout the quarter and the ranges are substantial.

Here are the sector returns for the first two quarters of 2022:

	1Q2022	2Q2022
Information Technology	-9.00%	-22.77%
Energy	+38.00%	-6.36%
Health Care	-3.37%	-7.21%
Real Estate	-6.71%	-16.89%
Consumer Staples	-0.94%	-5.49%
Consumer Discretionary	-9.45%	-28.84%
Industrials	-2.31%	-16.62%
Financials	-2.04%	-20.39%
Materials	-2.39%	-17.72%
Communication Services	-13.17%	-22.89%
Utilities	+4.30%	-5.10%

Reviewing the sector returns for just the second quarter of 2022 and the first six months of the year, we saw that:

• All sectors were painted red for the second quarter and only the Energy sector is green YTD;
• 7 of the 11 sectors saw double-digit declines in the second quarter and those same 7 saw double-digit declines YTD too;
• The defensive sectors (Utilities and Consumer Staples) turned in a relatively decent quarter and have held up relatively ok YTD;
• The interest-rate sensitive sectors (Information Technology and Financials specifically) struggled as the Fed raised rates; and
• The differences between the best (-5%) performing and worst (-29%) performing sectors in the first quarter was big.

The Fed, The Fed, The Fed

The Federal Reserve voted to increase the fed funds by an amount not seen in almost 30 years. From the Federal Reserve press release dated June 15, 2022:

“Overall economic activity appears to have picked up after edging down in the first quarter. Job gains have been robust in recent months, and the unemployment rate has remained low. Inflation remains elevated, reflecting supply and demand imbalances related to the pandemic, higher energy prices, and broader price pressures.

The invasion of Ukraine by Russia is causing tremendous human and economic hardship. The invasion and related events are creating additional upward pressure on inflation and are weighing on global economic activity. In addition, COVID-related lockdowns in China are likely to exacerbate supply chain disruptions. The Committee is highly attentive to inflation risks.

The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. In support of these goals, the Committee decided to raise the target range for the federal funds rate to 1 1/2 to 1-3/4 percent and anticipates that ongoing increases in the target range will be appropriate. In addition, the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities, as described in the Plans for Reducing the Size of the Federal Reserve’s Balance Sheet that were issued in May. The Committee is strongly committed to returning inflation to its 2 percent objective.”

This rate hike – as the previous hike earlier this year – was one of the most predictable and predicted rate movement the markets have ever seen. What was not predicted, however, was the magnitude of the rate hike.

“Clearly, today’s 75 basis point increase is an unusually large one, and I do not expect moves of this size to be common,” said Fed Chair Jerome Powell. And Powell also said that decisions will be made “meeting by meeting.”

Interestingly, as of the day after the Fed’s historic announcement, Wall Street assigned a probability of more than 80% that the Fed would raise rates by another 75 basis points at their next meeting at the end of July. And that probability has held steady through the end of June too.

GDP Slumps

As the quarter wound down, the Bureau of Economic Analysis released its 3rd estimate of 1st quarter GDP and reported that real gross domestic product decreased at an annual rate of 1.6%. Analysis. In the fourth quarter of 2021, real GDP increased 6.9%.

This 3rd estimate was notable in that the 2nd estimate issued last month reported that GDP declined 1.5%.

“The update primarily reflects a downward revision to personal consumption expenditures (PCE) that was partly offset by an upward revision to private inventory investment (refer to “Updates to GDP”).

The decrease in real GDP reflected decreases in exports, federal government spending, private inventory investment, and state and local government spending, while imports, which are a subtraction in the calculation of GDP, increased. Nonresidential fixed investment, PCE, and residential fixed investment increased.”

Housing Cools Off

The National Association of Realtors announced that existing-home sales retreated for the fourth consecutive month in May. Month-over-month sales declined in three out of four major U.S. regions, while year-over-year sales slipped in all four regions.

From the release:

• Total existing-home sales (completed transactions that include single-family homes, townhomes, condominiums and co-ops) fell 3.4% from April
• Year-over-year sales receded 8.6%

“Home sales have essentially returned to the levels seen in 2019 – prior to the pandemic – after two years of gangbuster performance. Also, the market movements of single-family and condominium sales are nearly equal, possibly implying that the preference towards suburban living over city life that had been present over the past two years is fading with a return to pre-pandemic conditions.”

• Total housing inventory registered at the end of May increased of 12.6% from April but dropped 4.1% from the previous year
• Unsold inventory sits at a 2.6-month supply at the current sales pace, up from 2.2 months in April and 2.5 months in May 2021

“Further sales declines should be expected in the upcoming months given housing affordability challenges from the sharp rise in mortgage rates this year. Nonetheless, homes priced appropriately are selling quickly and inventory levels still need to rise substantially – almost doubling – to cool home price appreciation and provide more options for home buyers.”

• The median existing-home price for all housing types in May was $407,600, up 14.8% from May 2021 as prices increased in all regions
• This marks 123 consecutive months of year- over- year increases, the longest- running streak on record

Further:

• Properties typically remained on the market for 16 days in May, down from 17 days in April and 17 days in May 2021
• Eighty- eight percent of homes sold in May 2022 were on the market for less than a month

The largest year- over- year median list price growth occurred in Miami (+45.9%), Nashville (+32.5%), and Orlando (+32.4%). Austin reported the highest growth in the share of homes that had their prices reduced compared to last year (+14.7 percentage points), followed by Las Vegas (+12.3 percentage points) and Phoenix (+11.6 percentage points).

Regional Breakdown

• Existing-home sales in the Northeast climbed 1.5% but fell 9.3% from May 2021. The median price in the Northeast was $409,700, a 6.7% rise from one year ago.
• Existing- home sales in the Midwest dropped 5.3% from the previous month and also fell 7.5% from May 2021. The median price in the Midwest was $294,500, up 9.5% from one year before.
• Existing-home sales in the South declined 2.8% in May and fell 8.4% from the previous year. The median price in the South was $375,000, a 20.6% jump from one year ago. For the 9th consecutive month, the South recorded the highest pace of price appreciation relative to the other three regions.
• Existing-home sales in the West slid 5.3% in May and dropped 10.0% from this time last year. The median price in the West was $633,800, an increase of 13.3% from May 2021.

Manufacturing Cools Off

S&P Global reported that we saw “the weakest upturn in US private sector output since January’s Omicron- induced slowdown in June. The rise in activity was the second- softest since July 2020, with slower service sector output growth accompanied by the first contraction in manufacturing production in two years.

• The headline Flash US PMI Composite Output Index registered 51.2 in June, down from 53.6 in May. The decline in the index reading signaled further easing in the rate of expansion in business activity to a pace notably slower than March’s recent peak. Although service providers continued to indicate a rise in output, it was the weakest increase for five months.
• Manufacturers fared worse, with factory production slipping into decline as the respective seasonally adjusted index fell to a degree only exceeded twice in the 15- year history of the survey, at the height of the initial pandemic lockdowns in 2020 and the height of the global financial crisis in 2008.
• Weaker demand conditions, often linked to the rising cost of living and falling confidence, led to the first contraction in new orders since July 2020. Decreases in new sales for goods and services in June were the first recorded since May and July 2020, respectively.
• Similarly, new export orders contracted at the steepest pace since June 2020 as foreign customers paused or reduced new order placements due to inflation and supply chain disruptions.
• Inflationary pressures remained marked in June, as input costs and output charges rose substantially again. Although the pace of input price inflation eased to the slowest for five months, it was sharper than any seen before April 2021. Alongside food, fuel, transportation and material price hikes, firms often mentioned that wages had increased to entice workers to stay, which added pressure to operating expenses.



• Finally, business confidence slumped to one of the greatest extents seen since comparable data were available in 2012, down to the lowest since September 2020. Manufacturers and service providers were far less upbeat regarding the outlook for output over the coming year than in May, principally amid inflationary concerns and the further impacts on customer spending as well as tightening financial conditions.”

Consumer Sentiment Hits Record Low

The University of Michigan’s Consumer Sentiment Index for June came in 14.4% below May for the lowest reading on record.

“Consumers across income, age, education, geographic region, political affiliation, stockholding and homeownership status all posted large declines. About 79% of consumers expected bad times in the year ahead for business conditions, the highest since 2009. Inflation continued to be of paramount concern to consumers; 47% of consumers blamed inflation for eroding their living standards, just one point shy of the all- time high last reached during the Great Recession.”

Orders for Durable Goods Up

Four days before the end of the quarter, the U.S. Census Bureau announced the May advance report on durable goods manufacturers” shipments, inventories and orders:

New Orders

• New orders for manufactured durable goods in May increased $1.9 billion or 0.7%
• This increase, up seven of the last eight months, followed a 0.4% April increase
• Excluding transportation, new orders increased 0.7%
• Excluding defense, new orders increased 0.6%
• Transportation equipment, up two consecutive months, led the increase, $0.7 billion or 0.8% to $87.6 billion

Shipments

• Shipments of manufactured durable goods in May, up twelve of the last thirteen months, increased $3.6 billion or 1.3% to $268.4 billion
• This followed a 0.3% April increase
• Transportation equipment, up seven of the last eight months, led the increase, $1.7 billion or 2.1% to $84.7 billion

Unfilled Orders

• Unfilled orders for manufactured durable goods in May, up twenty-one consecutive months, increased $3.7 billion or 0.3% to $1,109.8 billion
• This followed a 0.5% April increase
• Transportation equipment, up fifteen of the last sixteen months, led the increase, $2.9 billion or 0.5% to $639.8 billion

Inventories

• Inventories of manufactured durable goods in May, up sixteen consecutive months, increased $2.7 billion or 0.6% to $482.7 billion
• This followed a 0.9% April increase
• Machinery, up nineteen consecutive months, led the increase, $1.0 billion or 1.2% to $82.3 billion

Capital Goods

• Nondefense new orders for capital goods in May increased $0.4 billion or 0.5%
• Shipments increased $1.3 billion or 1.6%
• Unfilled orders increased $3.9 billion or 0.6%
• Inventories increased $0.6 billion or 0.3%
• Defense new orders for capital goods in May increased $0.3 billion or 2.6%
• Shipments increased $0.3 billion or 2.5%
• Unfilled orders decreased $0.2 billion or 0.1%
• Inventories increased $0.1 billion or 0.3%

 

Sources

bea.gov;census.gov;nar.realtor;umich.edu;spglobal.com;msci.com;fidelity.com;nasdaq.com;wsj.com; morningstar.com; census.gov;

QMC–2Q2022–FMeX