Economic Intelligence

The economy and stock market head into the second quarter of 2023 dealing with both headwinds and tailwinds after an unexpectedly strong start to the year. It was anything but smooth sailing though. A potential banking crisis tainted the first quarter, a great divide between the Federal Reserve – which seems firmly committed to its inflation fight, investors who stubbornly expect interest rate reductions before year-end, and a tough outlook for corporate earnings.

Finally, we close the books on 2022 which was the worst year for financial markets since the “Great Recession”. The S&P 500, Dow Jones Industrial Average, and the Nasdaq Composite all posted their biggest annual losses since 2008. This also ended a three-year winning streak for the major indices. The writing was on the wall back in November 2021 when the Federal Reserve finally recognized it was time for easy monetary policy to come to an end which it had kept in place for over a decade. Exponentially increasing interest rates, the highest inflation since 1981 and fears of an economic recession were some of the primary causes of this year’s pain.

The cheerleaders of passive indexing have fallen quiet after a decade of yelling that passive indexing is the only way to invest money. As I have stated many times, passive indexing looks great in bull markets. However, it can be a very quick way to destroy capital in bear markets.

The third quarter started with renewed investor optimism but ended with a crushing reminder that the worst is yet to come. The bear market rally that started in mid-June continued through July and into August. However, further signs of sky-high inflation, necessary interest rate hikes, and increasing probability of a “hard landing” and recession in 2023 smashed all hope. Between mid-August and the end of September, the S&P 500 Index dropped almost 17% and closed out the quarter at a new bear market low of 3585.62 (over 100 points below the prior low reached in mid-June).