ECONOMIC COMMENTARY

CIO Note: When good news is bad news

Strong employment hasn’t led to strong returns as the Fed doubles down on inflation.

Key takeaways

  • Investors suffered through a tough September as equities and bonds ended the quarter on a low note while central bank tightening and fears of a recession took hold after a summer respite. 

  • Employment remains strong in the U.S. and that is a problem for the Fed as it focuses instead on the other half of its mandate, inflation. 

  • Housing market activity has taken a hit as mortgage rates rise. However, when put in a historical context, there are reasons for optimism. 


"Summer's lease hath all too short a date." - William Shakespeare

A chill in the air for investors

September was another challenging month in the markets, as the gains from the June-August rally, that brief summer respite within a now lengthening bear market, were washed away as inflation failed to subside. The S&P 500 lost -4.88% for the third quarter, and -2.88% of that loss came in the last week of the month. U.S. small cap stocks fared better in the third quarter, down only -2.19%, but international developed and emerging market stocks gave up any relative outperformance to the U.S. during the quarter as the strong dollar weighed on returns for U.S. investors. 

U.S. corporate bonds struggled in the quarter as well, losing over -5% as rates rose sharply on the Fed’s more hawkish guidance. Interestingly, high yield corporates have outperformed high quality bonds handily year-to-date, and investors are citing the stability in the credit markets as an indication that a deep, sustained recession is not currently priced into the bond markets. Commodities remain under pressure, as WTI crude once again closed the week under the $80 per barrel mark, and gold sits at $1,672 per ounce – well off its 2021 year end mark. 

The question then arises, where do we go from here? In the short term, at least through early November, continued choppiness is likely as investors remain anxious about restrictive global central bank policy, the threat of a deep recession in 2023 on the back of much lower consumer demand, and the ever-present overhang of geopolitical tensions with Russia and China. As such, the “buy the dip” mentality that has dominated the equity markets over the last several years, in our view should give way to a “reset and reallocate” mentality. 

The rise in bond yields, although painful for current bondholders, has afforded investors the opportunity to reset their expectations for how returns can be generated over the next several years, and could potentially allow investors to reallocate their risk budget to a more balanced approach. 

While we believe that the equity markets could post sizable gains on the back of this year’s declines, based on historical experience, for investors who have shorter time horizons, or for whom there are liquidity needs in the next several years, there are benefits to reallocating a portion of the portfolio to high quality fixed income as equity markets recover. 

Our belief is that we will see a recovery in equities, and therefore a reallocation away from stocks at this junction in any meaningful way is not advisable. However, should they recover, this reassessment of needs and desired outcome is one which we believe would be beneficial given the significant changes in the fixed income market this year. 



The Fed continues to keep a sharp eye on inflation

One of the bright spots in the post-pandemic recovery has been the bounce back in the U.S. labor market. Given where we are today, it is important to consider that in April of 2020, the unemployment rate was almost at 15% as the services industry was crushed by Covid-19. Widespread layoffs and shuttered businesses gave way to massive hiring through 2021 and into early 2022 as businesses were unable to meet demand for goods and services as the U.S. consumer, flush with savings and stimulus, returned to pre-pandemic levels of activity. 

Job openings hit their peak in May of this year, at 11.86 million, while the number of unemployed persons seeking work bottomed around 4.7 million in April. This mismatch between hiring and available workers resulted in meaningful wage growth, which transmitted into higher prices for end consumers as well as providing additional funds for spending.  

As the Fed has gotten increasingly tough on inflation, it has become clear that the full employment side of the dual mandate has been deemphasized. Comments from a number of Fed governors, as well as Chair Jerome Powell, have indicated that the Fed is willing to let unemployment tick higher and, in order to get inflation under control, wage growth, and therefore demand for new hires, must decline. Not only will the economy need to slow enough to force a decline in job openings, which has admittedly already begun, but companies will need to start cutting jobs at a significant clip in order to depress consumer spending enough to allow prices to moderate.  

Now what if that doesn’t occur fast enough? The non-farm payrolls release for September showed that the U.S. economy added +263k jobs in the month, with wages growing by +5% year-over-year. The unemployment rate actually fell in the month to 3.5%, but admittedly that was on the back of a slight decline in the participation rate. 

Overall, the report pointed to a moderating labor market, which is hardly a surprise given the expectations for lower growth next year. What the report did not show, however, is that the announced layoffs in areas such as technology and in certain professional services such as investment banking are spreading to the broader economy. 

It is this disconnect that sent investors reeling as the hopes for a Fed pivot or pause prior to the end of the year are dependent on inflation and employment data coming in better-than-expected, and any print that appears to point to a resilient consumer is likely to re-affirm the Fed’s stance. Rather than cheering the fact that the U.S. economy has thus far avoided a recession, investors are instead pining for a pivot – one that is not likely to come as quickly as some might like.  



The housing market's current conundrum

The housing market’s resurgence coming out of the depths of the pandemic in mid-2020 was a boost to economic activity in 2020 and 2021 and also represented the sharpest increase in the sale of existing homes since prior to the 2008 financial crisis. Driven by a desire for more space or perhaps just a change of pace, many buyers who perhaps would have already been homeowners in prior decades took advantage of the low rate environment and flooded into the market. Sales shot higher while supply remained essentially the same creating competition for homes not seen in over a decade. 

This trend reversed swiftly beginning in early 2022, as rising mortgage rates coupled with now lofty prices to create an affordability challenge for many buyers, particularly first-time homebuyers who were not able to benefit from the sale of an existing property. One could argue that the situation is similar to what occurred during 2007 as sales fell throughout the year ahead of what would become a massive dislocation in property prices in 2008.  

However, there are other factors to consider in terms of a potential recovery in housing demand. First, supply is much lower today than it was during that period. In 2007, the supply of single-family homes in the U.S. was over 9 months – today it sits just over 3 months, well below the historical average. 

Single family homes are not being produced at a fast enough pace in the U.S. to meet prospective demand, particularly in growing markets, and with input costs and supply chain delays hindering construction, the issue is unlikely to be alleviated anytime soon. In addition, existing home sales are being impacted by mortgage seekers as well as owners who have mortgage rates in the 2-3% range and delaying moves or even remodeling to avoid selling and being forced to finance at a higher rate.  

In our view, the biggest potential catalysts for the housing market to stabilize over the next several years are accelerating household formation coupled with rising rents. According to Redfin data, rents increased by +11% year-over-year in August, and while home prices are still rising at a faster pace than rents, the cooling demand for homes resulted in the sharpest month-over-month decline ever in July for the S&P CoreLogic Case-Shiller Index, which measures home prices across a number of U.S. geographies. 

In addition, only 43% of millennials own a home according to data from Freddie Mac released last year, and that is well below the national average of 65%. As millennials approach 40, the pace of household formation has been accelerating, and this group could provide the lift to the housing market over the next decade. 



We encourage you to reach out to your Wealth Advisor for a deeper discussion on the points above, or a review of your current plan to ensure it remains aligned with your long term needs and goals.

Shannon Saccocia, CFA, CIMA®

Shannon Saccocia serves as Chief Investment Officer at SVB Private, and is responsible for setting the overall investment strategy for the firm. She oversees the asset allocation, research, portfolio management, external manager search and selection, portfolio implementation, trading, and investment risk management functions.

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