“Higher interest rates, slower growth and a softening labor market are all painful for the public that we serve, but they’re not as painful as failing to restore price stability and having to come back and do it down the road again,” Fed Chairman Jerome Powell, 9/21/22, after the Fed hiked the Fed Funds rate another 0.75%.
The higher interest rates put in place by the Federal Reserve to battle inflation will continue to slow the economy and likely reduce corporate earnings. At the same time, they will impact the prices that investors are willing to pay for a dollar of a company’s profit (e.g. lower price/earnings ratios). Through the first three-quarters of 2022, the S&P 500 Index has fallen 24% despite growing earnings, as rising interest rates have reduced the higher valuations that stocks enjoyed for much of the pandemic era.
In these uncertain times, investors are seeking answers to questions about the future: How much further will the Fed raise rates? Will the stock market fall further in bear market territory? Will the US enter a recession soon, or has it already? The uncertainty isn’t going to go away. In fact, markets may react to midterm election anxiety and fiscal policy unknowns in addition to geopolitical concerns, most notably surrounding Russia’s invasion of Ukraine and China’s strategic aspirations. Given this environment, continued volatile markets would not be surprising.
Now, for the good news: There is opportunity in all markets. Building wealth doesn’t require a perfect economic backdrop. If it did, no one would ever make money. However, by paying more attention to company-specific fundamentals, this volatility provides opportunities for our team to add value through proprietary research and individual security selection.
The best performers in terms of stock performance and yields are dividend growth stocks that have solid cash-generating businesses—and a long history of raising dividends. These securities are considered a good buffer during times of market volatility. They also are seen as an inflation hedge, considering that S&P 500 dividend growth has significantly outpaced inflation since 1957.
In the second quarter of 2022, dividend payouts by U.S. companies in the S&P 500 set a record despite rising interest rates, inflation, and an economic slowdown. They totaled $140.6 billion, up 14% from $123.4 billion in the year-earlier quarter, according to S&P Dow Jones Indices. “It’s expected this trend will continue in the third quarter and through year’s end,” says Anu Ganti, senior director of index investment strategy at the company. Thus, we continue to seek out solid companies with strong cash flows that are well positioned to remain profitable during economic downturns.
A good rule to always follow, especially in the current market environment, is to think longer term. Actually, you cannot be an investor in the stock market and not have a long-term time horizon. Don’t allow the short-term headlines—which are causing a lot of volatility—to introduce panic into your investment decisions. Throughout my over 40 years as a fiduciary investment advisor, there’s never been a day that the market hasn’t faced unknowns and what ifs. However, if you take a disciplined approach and don’t get caught up in the short-term noise, you don’t need certainty about the markets and the economy to achieve your long-term financial goals.