Global financial markets declined again in the third quarter as inflation persisted and remained at 40-year highs, geopolitical tensions escalated even further, and the Federal Reserve continued to aggressively raise interest rates. In late July, the Federal Reserve (the “Fed”) raised interest rates by another 75 bps but comments by the Fed Chair, Jerome Powell, indicated a potential deceleration of the pace of interest rate hikes which gave the equity markets a boost in July and early August. Things took a dramatic turn in mid-August when Powell remarked the Fed would do what is needed to tame inflation and warned the U.S. economy will likely feel some “pain” from the Fed’s action. Markets continued to sell-off in September as the August Consumer Price Index (CPI) report showed a slight increase in prices and the Federal Reserve raised interest rates again by 75 bps.
All major market indices finished the quarter with negative returns. Equity markets, as measured by the S&P 500 Inde1, fell by 4.9% during the quarter and is down almost 24% on a year-to-date basis.
With inflation persisting during the quarter, long term interest rates continued to surge. The 10-year U.S. Treasury started the quarter at 2.9%, hitting almost 4% during the quarter and subsequently finished the quarter at 3.8%. T-Bills posted a slightly positive return during the quarter, but all other fixed income indexes were negative with longer-dated government bonds posting the worst relative returns.
Unlike the first half of the year, growth outperformed value in the third quarter. Growth experienced a strong rebound early in the quarter with a bear market rally, however, much of those gains were erased by the end of quarter. On a sector level, only one sector of the S&P 500 finished the third quarter with a positive return. Consumer discretionary was slightly positive for the quarter due to strong consumer spending and low unemployment. The sector laggards for the quarter were communication services, real estate, and materials. Real estate declined as mortgage rates rose and home prices began to soften.
Foreign markets underperformed the U.S. markets during the third quarter as the US dollar continued to strengthen, energy prices surged in Europe and the U.K., and the European Central Bank and Bank of England raised interest rates to combat persistent inflation. Emerging markets fared worse than foreign developed markets with the surge in the U.S. dollar and rising fears of a global recession.
Real economic growth contracted during the first two quarters of the year, but the advance estimate of Q3 GDP showed a 2.6% annual growth rate for the economy. Despite lingering inflation and prolonged supply chain issues, the majority of Q2 earnings reports beat estimates indicating corporate America may be more resilient than previously believed by the markets.
The labor market tightened even more in the third quarter with 1.1 million jobs added to the U.S. economy. Jobs in leisure and hospitality and healthcare led the way. The overall U.S. unemployment rate remains at historic low levels at 3.5% with the total number of unemployed people standing at 5.8 million.
Inflation, as measured by the Consumer Price Index (CPI-U), grew at a pace of 8.2% for the past 12-month period ending September 30, 2022. The core inflation reading, which excludes food and energy, rose 6.6%. Rising prices for shelter, food and medical care were slightly offset by a decline in gasoline prices.