Robert Ryan

December 5, 2022

Investment Committee

Rockbridge Institutional – November 2022 Market Review

MARKET COMMENTARY

Stocks

After this week’s ups and downs, stocks ended November up nicely – international and emerging market stocks leading the way earning 11% and 15%, respectively. While not as robust, domestic large cap markets were up 6% and small-company markets returned 2%. These results bring the quarter-to-date returns to 14% for domestic markets, 17% for developed international markets and 11% for emerging markets – a welcome improvement over the first three quarters and consistent with a generally improving economic outlook.

Value markets – both domestic and international – are trading at premiums to broad markets. Year-to-date, the value premium in domestic markets was nearly 12%, in international markets just under 8%. Prices of value stocks reflect earnings from assets in place and less from future investments. These stocks are generally identified by relatively low price earning ratios. Because earnings are not as far off, increasing interest rates have a smaller impact on prices of value stocks and help to explain recent premiums.

Stock prices reflect the future, which is always unknown. The recent upswing is surely positive, but uncertainty remains. No doubt there will be surprises ahead.

Bonds

Yields on bonds at the short end moved up the last month, reflecting the push by the Fed to increase Federal Funds rates. Yields at the longer end were down a bit as well. Yields peak at one-year maturity and fall off to 3.8% at five years. This sharp inversion indicates lower interest rates ahead and often predicts a recession. The spread between real (inflation-adjusted) and nominal yields at both five- and ten-year maturities (about 2.3%) is consistent with the Fed’s long-term inflation objectives.

A Perspective on Inflation

Inflation can often be explained by too much money chasing too few goods. This description is consistent with the recent economic environment. One source of too much money is the massive stimulus payments made in 2021 to counteract the impact of Covid. These payments become inflationary if they exceed what is necessary to bring the economy to full capacity. The disruptions in the supply chain throughout the pandemic, and constraints in energy supplies from the invasion of Ukraine, meant too few goods. Additionally, throughout this period the Fed was especially accommodative. That inflation resulted should not be a surprise.

The landscape looks different today. Stimulus payments are beginning to work through the economy; supplies are more readily available; embargos seem to have reached a “steady-state,” and; the Fed is committed to being more restrictive. All of which should dampen inflation pressures. The bond market continues to signal benign inflation expectations. Stock markets appear to anticipate a more relaxed interest rate environment, which helps to explain recent positive stock markets.Yet, there are risks with this improving outlook: fiscal and monetary policies can overshoot the mark and either trigger a serious recession or reignite inflation; inflation becomes expected, and consequently, embedded in future transactions and self-fulfilling; and labor markets continue to tighten, driving up wages. Uncertainty remains, and it is reasonable to expect market ups and downs as this future unfolds. Yet, the current inflation and interest rate environment appears to be improving.

WHO WE ARE

Rockbridge Institutional serves the unique needs of institutions, foundations, and endowments by applying a disciplined, proven and responsible investment philosophy. We are intimately familiar with the challenges boards face as we serve on boards and finance committees ourselves.

We are committed to investment ideas that are grounded in academic research. The essence of our investment philosophy is that capital markets work in the long run; a portfolio’s risk is defined by its allocation among asset classes; and that security selection is a matter of constructing portfolios with specific expected return/risk characteristics at the lowest cost.

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