Weekly Investment Update (09/30/2022)

Further Signs of Disinflation Will Be Key for Markets and the Economy

Heightened inflation has been a root cause of the current market and economic woes. Further proof of disinflation will be a key factor driving both in a positive direction from here. Even with softening economic growth, inflation has not eased as much as investors hoped for by this point. While it is not surprising after the firm PPI and CPI reports, August’s PCE also came in on the hotter side with headline inflation of 6.2% relative to expectations for 6.0% and core inflation of 4.9% versus expectations for 4.7%. Since PCE is the Fed’s preferred gauge of inflation, the case for another 75bp hike in November is likely further solidified by this report.

While Fed policy is affected by this lagging data of where inflation has been, it is important to look toward future trends of where inflation is going. We remain encouraged by the increasing number of data points that reveal notable softening in pricing pressure — including commodity inputs, housing costs, shipping rates, and goods and autos prices. Increases in these areas have contributed to higher inflation data in recent months and years, and we are now seeing initial signs of disinflation, even if it will take time for the price declines to make their way into the official data.

Please see our Quarterly Investment Perspective, which will be published on Monday, October 3, for more detailed thoughts on the current investment landscape.

Equity Markets Holding to Support Levels With Sentiment and Price Action Providing Potential Tailwinds

Investor psychology remains uncertain, with the market exhibiting notable declines on the back of any incremental negative news, often with sizeable jumps the following day. The American Association of Individual Investors bearish reading came in above 60% for the second week in a row, the first time the reading has held at this level in the history of the data series going back to 1987. We continue to note that with such panic and pessimism in addition to oversold market conditions, negative sentiment and price action remain potential market tailwinds that have historically spurred sizeable bouncebacks from these levels.

On the technical front, the S&P 500 and Nasdaq are holding on to structural support levels at year-to-date lows and long-term moving averages. The S&P 500 is appearing to consolidate around its June intraday low. These extreme support levels have been indicative of major market troughs since 2009. Next week, we are moving into the strongest seasonal period for equity markets. Given heightened market volatility, we will be cautiously looking for further evidence of the market putting in a double bottom low near current structural support levels.

Bank of England Looks to Calm Gilt Markets

Bank of England Looks to Calm Gilt Markets Following the U.K.’s fiscal plan announcement last week (see last week’s Weekly Investment Update), volatility has spiked in the gilt market, the market for bonds issued by the British government. With the aim of calming markets, the Bank of England issued a statement on Wednesday saying that it would postpone gilt sales until October 31. Meanwhile, it will engage in temporary long-dated gilt purchases from September 28 until October 14 this year. In seeking to stabilize and restore confidence in the U.K. asset markets, the bank noted that “the purchases will be carried out on whatever scale is necessary to effect this outcome.” These bond purchases should provide some liquidity to the market and mitigate the potential for a spiraling sell-off in long-duration gilt yields in the short term. As a result, 30-year gilts fell from 5.0% on Tuesday to 3.9% on Wednesday, reversing much of the move that occurred during the week prior.

Still, it is likely that a large rate hike by the BoE in November will be needed to combat an increase in inflation expectations and to restore financial stability. A 150-basis-point move is now priced into markets ahead of its November meeting — an amount that has doubled in the past week. However, one positive may be that risk of macro spillovers could cause the Fed to provide more calming signals to the markets in order to mitigate concerns abroad. The strength in the dollar is the conduit whereby hawkish Fed policy is causing volatility abroad, in Japan and some emerging markets in addition to the U.K. Already, FOMC Vice Chair Brainard has acknowledged how these global developments have been affected by Fed policy. As the BoE looks to sharply hike rates into a potential recessionary environment in the U.K., Bessemer portfolios remain underweight the U.K. relative to respective benchmarks. Within equities, portfolios have a 2% allocation to the U.K. relative to 4% for the benchmark.

Rising Interest Rates Continue to Slow the Housing Market

The Fed’s rapid pace of hiking rates has a direct feed through to the housing market, and the effects of tighter monetary policy are increasingly evident in softening housing activity. As global market fears intensified and central banks continue on their path of raising short-term interest rates to fight inflation, the 10-year Treasury yield has moved higher, surging above 4.0% this week. Mortgage rates have followed the increase in the 10-year Treasury yield with the average 30-year fixed-rate loan reaching 6.7%, the highest level since 2007.

Data have continued to reveal a slowing housing market. The National Association of Home Builders index fell in September for the ninth consecutive month as rising mortgage rates and decreased affordability suppressed activity. U.S. pending home sales fell for the seventh time this year. While building permits declined on the back of weakening demand, housing starts and new home sales jumped more than anticipated, showing some market resiliency. While we would expect higher mortgage rates to continue to pressure the housing market, still-strong market fundamentals, years of underbuilding new homes, and ongoing demographic tailwinds imply that the risk of a housing crisis similar to 2007 remains low.

As housing activity slows, it may take time to see housing costs cool materially and for easing price pressure to appear in inflation data. While housing and rent prices are starting to decline from peak levels, there is a lagged effect regarding how the data feed through to shelter inflation readings. Shelter inflation is likely to stay sticky for some time; still, the Fed is likely to welcome the initial signs of slowing in the housing market as the effects of central bank policy are reflected in the real economy.

Bessemer portfolios have exposure to floating-rate mortgage bonds within the Credit Income fund. These securities have been performing well as they earn more yield as interest rates rise, and the high-quality borrowers are continuing to pay down their mortgages over time. Portfolios have little other direct exposure to housing.