Capitulation Has Hit Financial Markets; How We're Positioning

To get our market insights delivered directly to your inbox, sign up here.

Friday, September 23rd, capitulation hit financial markets, with stocks, bonds, cryptocurrencies, and commodities all trading meaningfully lower.

The major catalyst for the selloff was the Federal Reserve meeting earlier last week, when Fed officials forecasted that the effective funds rate would peak at 4.6% in 2023, above previous expectations. It appears that Fed Chairman Jerome Powell is delivering on his previous statements that the Fed may have to “bring some pain to households and businesses", which he described as “the unfortunate costs of reducing inflation.”

Following last week's announcement, I believe that market is already pricing in a housing downturn and is closing in on pricing in a 100% probability of near-term recession, compared to a roughly 50% probability of recession as of early July. It's important to note that not all recessions are created equal, and with the unemployment rate at 3.7% as of August 2022, I continue to expect a mild recession. I also believe that the Fed is acting appropriately to bring inflation closer to its 2% target.

Thursday night Goldman Sachs cut its S&P 500 Index year-end target to 3,600, which implies a 2.5% drop from current levels. In the event of a major recession, Goldman expects the S&P 500 to bottom at 3,150, a 14.7% drop from current levels. A recent Bank of America report suggests that investor sentiment is “unquestionably” the worst it’s been since the 2008 Financial Crisis.

During turbulent times for the markets, I often turn to the Warren Buffet adage to be “fearful when others are greedy, and greedy when others are fearful.” It's important to note that as of Friday's close, the S&P 500 Index stands at 3,693, and the Chicago Board Options Exchange's CBOE Volatility Index (VIX) stands at 29.9. It's worth noting that in recent history, when the VIX has approached a level of 30, we've seen local lows in the equity markets, as shown below:

​Nonetheless, with potential near-term pressure to economic fundamentals, I remain cautious, and am generally not recommending that clients add risk. My focus is now on the 3Q22 earnings season, which kicks off in mid-October. As major U.S. companies report and provide guidance for 2023, we'll have a better sense of ongoing and expected business conditions, which will likely catalyze the market's next direction.

I've had many conversations with clients over the last several days and weeks. Some are reducing risk, and in many of those cases I've been allocating capital into short-term treasury bonds, which are yielding in excess of 3.5% and carry low duration risk. Other clients prefer to add risk at lower valuations, and in those cases I've allocated capital into renewable energy, cloud computing, and blue chip technology stocks. In my personal portfolio, I've captured some losses and identified opportunities to reinvest into the industries mentioned above.

On the whole, our positioning today remains defensive; however, each strategy is tailored to our clients' unique investment time horizon and level of risk tolerance. If you have any questions about your portfolio or positioning, you're welcome to email me directly or schedule a call via this link.