The Monthly Mosaic | September 2022


So far in 2022, the story has been largely inflation. So we started the year with increasing inflation, markets selling off in response to inflation, Federal Reserve behind the curve, and then having to come in more forceful. So we had started all year as an inflationary aspect in terms of what was causing on the market turbulence by mid-June moved into an area where inflation was coming to a degree that the Fed was really going to have to step up their efforts. This year, the Federal Reserve has increased interest rates four different times by a total of 2.25%. So now the Fed funds rate is between two and a quarter to two and a half percent. Just to put that in a little bit more context, that's happened in six months here in 2022. If you go back to the last fed hike cycle, it took nearly three years to make that same kind of above 2% Increase the Fed funds rate. So there's been a lot in a very short amount of time, and I think the market is still trying to figure out exactly what that means for the coming days.

The Fed is not done raising interest rates, and I think that was clear in the Jackson Hole speech, when chair Powell came out, made a very short speech, he was about eight minutes long. So it was one of the shortest Jackson Hole speeches that we've seen in a long, long time. But really, the message was, the job's not done, we're going to continue hiking interest rates until we get inflation under control. And that was a big deal. Why we've seen equity market volatility become even larger sense was because since the middle of June and into July, a lot of the market became convinced that there's maybe a soft pivot and the Fed would be done hiking interest rates by early spring next year, and would then start moving into cutting interest rates. So Powell coming out, being very forceful, has caused more volatility in the marketplace in the last several weeks.

Global Economic Outlook: Widespread Inflation

So the Fed actually has been one of the few central banks that's been raising quite strongly Bank of Australia has been raising quite heavily. Here, just this week, we have the European Central Bank, which is farther behind the curve. They're dealing with an economy that's in a much worse position, given the energy shortages, and what's hitting the European economy. The ECB, just here, this week hiked interest rates, 75 basis points. Really is what's looking like into a recession. So Europe is in a very tight spot. Overall, inflation continues to be a bigger issue in Europe, because of the energy side, especially Europe and the UK, US obviously, inflation is still an issue. But yes, it's a widespread inflationary issue across the developed world. Emerging markets, not quite having quite as big of a difficulty given that their interest rates were a lot much higher to begin with.

We continue to look at China as a potential source of stimulus, they have the ability to stimulate and really haven't. So that's one of the areas that we've been spending a lot of time watching. We don't have much of an allocation in portfolios to China, but they are kind of on the flip side of what we're facing here with the Federal Reserve. They actually have the ability to cut interest rates and do more fiscal stimulus, they're choosing not to, they are choosing to continue on the COVID zero policy. But that's one area of the globe that we see that could actually provide somewhat of a spark if they were to choose to become more stimulative in their policies.

Equity Portfolio Positioning

It's been a very volatile year for equities throughout the beginning of the year, most of the decline in equities is really from the client and the multiple where earnings estimates really weren't coming down. So one of the reasons why we're still cautious, at least why we don't think maybe it's time to start aggressively buying equities at this point in time, even though there has been a pretty big downside, is because we do still see the economy moving slower. The potential for recession continues to build. Obviously, we've had two consecutive negative quarters of GDP growth. But there's still a lot of aspects that are doing well. So we do see volatility in the equity markets continuing. And we do see a downside for earnings expectations, which we think could be one of the reasons why you could still continue to see probably a difficult equity market ahead. Within our equity allocations, we're continuing to focus on quality and really more of a defensive aspect. So we have continued to insulate the portfolio looking at quality, trying to stay away from areas that are more impacted by inflation, things like consumer discretionary, which we've been avoiding all year, still do, like the energy side still looks interesting to us from just what's happening on the supply side of energy. We still favor the US over the international markets, you know, looking at the European situation, obviously either in a recession or probably going to be looking at a more severe recession. China continues to be very tight in terms of what they're doing from a COVID policy and also not stimulating their economy. And one of the unique things that we've seen is that in the international markets, especially in the eurozone, there hasn't been a large amount of attrition relative to the US just on stocks. It's really been more of the currency that's taken the European markets down. So when we look at the s&p versus the local eurozone market, they're really within about a percent year to date. So to us, it's still Eurozone might not be real prices aren't necessarily reflecting the kind of economic situation they find themselves in with the energy crisis.

Fixed Income Portfolio Positioning

Within the fixed income markets this year, it's been very challenging. Double-digit losses, things that investors haven't seen in a long, long time on the conservative side. But with that, we've seen a lot of yields come back into the marketplace. So there are some opportunities coming up where you don't have to take a lot of risk, you can get back into the fixed income markets, we generally feel better about the fixed income markets right now than equities given the economic cycle that we find ourselves in. But yields again, aggregate bond yield right now about 4%, intermediate corporates, four and a half, four and a half to four and three quarters. So some pretty good yields there that you can get. The one thing that we are cautioning people right now is that the corporate side, from a spread level is not reflecting kind of the economic slowdown potential for recession that we see. So right now, the overall spread level still below the average of the last 20 years. If we get into more economic stress, you're gonna see those spreads widen out and you're gonna have some underperformance in the corporate bonds versus treasuries. So in last couple months, we have kind of improved the quality, took the overall corporate bond allocations back down and focused on the higher quality treasury and mortgage markets.

We've been defensive most of the year. We had taken a lot of the growth equities out of the portfolios last year, as you move into a slower economy with interest rates settle in, you know those growth stocks, technology, stocks are actually have reprice quite a bit and we have started to slowly move back into the girls side that we would that we moved out of last year. Again, everything we're doing the portfolio's right now is increasing quality trying to increase defense. We still see quite a bit of volatility ahead of us and we think that right now, although the equity market has has come back to us a lot this year, we don't believe it's a time for a lot of offense yet and we're still on the defensive side of the portfolios.

“Madison” and/or “Madison Investments” is the unifying tradename of Madison Investment Holdings, Inc., Madison Asset Management, LLC (“MAM”), and Madison Investment Advisors, LLC (“MIA”), which also includes the Madison Scottsdale office. MAM and MIA are registered as investment advisers with the U.S. Securities and Exchange Commission. Madison Funds are distributed by MFD Distributor, LLC. MFD Distributor, LLC is registered with the U.S. Securities and Exchange Commission as a broker-dealer and is a member firm of the Financial Industry Regulatory Authority. The home office for each firm listed above is 550 Science Drive, Madison, WI 53711. Madison’s toll-free number is 800-767-0300.

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