Understanding Current Market Volatility

Breakwater Team • September 24, 2022

Yuck… some of you may feel compelled to swap out the first letter of the word I’ve chosen to describe the month of September, or frankly all of 2022 to this point. If you feel like you just got out of the ring with Muhammad Ali (circa the Sonny Liston days) you are not alone. With a little over three months to go before the calendar flips over, 2022 may very well go down as one of the worst years for the markets going back to the 1930s. Narrowing the field of vision to the start of this century, only 2008, during the Great Financial Crisis when the market declined 37% and 2002, where the aftermath of the bursting of the dot com bubble was compounded by the tragic events of 9/11 leading the S&P 500 to shed 22% then. As of the close of trading on September 23rd, the market is down 21.6%, so just a hair from taking over the number 2 spot, and for many this feels far worse. Whether it’s the fact that diversification this year has provided no real cushion (the bond market is down over 12%, it’s worst year on record) as has been the case in the past, the seemingly endless daily volatility or that many investors were broadly over-exposed to stocks after a long bull market, especially some of the high beta growth stocks that were highfliers in the early days of the pandemic market euphoria, the pain has been acutely felt everywhere. From time to time I’ll informally survey clients to get a pulse on their feelings, I would not be exaggerating when I say that for many this feels like perhaps their worst year in their experience. The breathtaking declines over the 5-week span in February-March of 2020 when the market dived 35% or Black Monday’s 22.6% drop which had been proceeded by a 4.6% drop the Friday prior were so swift that an investor wasn’t even able to formulate a strategy before it was all over. Those two years somehow managed to end the year in the black, very hard to fathom us being so fortunate today. 


So what is going on… You can attribute the market weakness to several factors, some of which I’ll expand on below, though in the end much of it boils down to the fact there is a significant amount of short-term uncertainty and a crisis of confidence.

  • Higher rates mean lower valuations
  • Connally’s famous quote, “the dollar is our currency, but it’s your problem”
  • Geopolitical developments, by now we all understand the war in Ukraine has wreaked havoc on European energy markets likely leading to a pretty significant recession on the continent while in the Far East, the Chinese continue to embrace a draconian lockdown policy to limit Covid’s spread. The Iran Nuclear deal, an election in Brazil and the return of Reaganomics in the UK are other notable matters, but this list is hardly exhaustive
  • Quantitative tightening accelerates 
  • The prospect of an imminent earnings decline meaning current estimates are too high thus a further correction may be needed to support valuations


Rather than unpack each of the points and sure you could probably throw others into the fold (domestic policy/politics to name one) I’ll address a few of them in depth and spare you where I think your exposure to the subject matter has more than reached its saturation point. Here is an anecdote along those lines. In speaking with my father this past week, and I am paraphrasing here, but he referenced how the Fed’s announcement and Powell’s presser represented somewhat of a must-see television event. Keep in mind that while my father is a worldly character and astute investor, our conversations rarely wander into the topic of interest rate policy. In reflecting on that comment, I found myself somewhat alarmed by the fact that there is far too much focus on short term headlines many of which are only modestly relevant to one’s long-term investment objectives. When we find ourselves obsessing over every detail of a single data point, at a point in time, we are bound to lose sight of the bigger picture, hopefully this note helps with re-anchoring our investment expectations as we persevere through this rough patch. 


1. Valuations & Earnings: Stocks have rerated from a multiple of 21 when we entered the year to about 15.5 according to current FactSet estimates, with this being the result of a collapse in P(rice) while E(arnings) have held up. Chalk up the latter to a resilient consumer and nimble and efficient corporations , the question of how sustainable this phenomenon is we’ll return to in a moment. When real interest rates were negative you could essentially pay anything for a company and end up ahead, so long as they had some earnings, which is perplexing why stocks that have yet to actual earn anything or will ever in the future commanded such high prices, but now with real yields positive and mid-single digit returns available in the investment grade debt market nosebleed valuations cannot be justified. There is a simple formula to arrive at the P/E for the market, yes it’s an oversimplification but helpful nonetheless. When taking the number 20, and subtracting the rate of inflation you could arrive at a reasonable P/E for stocks. Using the Fed’s 2% target meant 18X was not out of the question, even if it was higher than the long run average of 16X over the last 100 years or so. With inflation now at 8.3% according to CPI that would mean the market should be trading at less than 12X or about 20% less than it is today. I am not predicting that type of further rerating just sharing one perspective. Assuming inflation starts to trend back down to the 3-4% territory over the next 12-18 months, you are still looking at equities that are around fair value versus a screaming buy, which is where we were after the most recent large sell offs in 2020 and Q’4 2018. That math assumes earnings hold up, if not even grow modestly over the next few quarters (the consensus is still calling for 3.2% growth in Q’3 earnings which we’ll start to hear in another 2-3 weeks.) The issue is that if earnings deteriorate, prices have further to fall. With the Fed calling for an unemployment rate to rise to 4.4% in 2023 & 2024 (I would describe this optimistic view as a soft landing) we are taking about 1.4MM Americans losing their jobs not to mention the limited spending power of our allies in Europe or in other parts of the globe. If earnings decline by 10%, then we are probably okay here, but if earnings follow their typical path in a recession and drop by around 25-30% it stands to reason that prices would need to go lower to support this multiple. This is why you have seen a number of the big Wall Street firms lowering their year end estimates for the S&P, for example David Kostin at Goldman clipped their figure to 3600 earlier this week. 


Below is the link to Factset’s piece from yesterday which is chockfull of insightful data on earnings


2. If you converted your dollars to pound sterling right now, you’d actually feel a little wealthier than you did when opining about your New Year’s resolution back in January. There has been an important development that has not received nearly as much attention as warranted, the meteoric rise of the dollar against much of the currency complex. We have seen dollar Euro parity recently, it’s now below the dollar. The UK’s pound sterling is all the way down to $1.04 versus the dollar, I recall when the exchange rate was over $2.00 prior to the GFC and the Japanese Yen is back to levels last seen in the midst of the “Asian Flu” in 1998. Why is this important? Primarily it can exacerbate inflation abroad given that many commodities are dominated in dollars thus adversely affecting countries already impacted by supply chain issues, an energy embargo or the limited access to supply due to geography or as a result of the underinvestment in natural resources over the last decade. Another issue here is due to the fact the dollar is the reserve currency and thus plays significant role in the funding/credit markets. Given the propensity for countries looking to issue greenback denominated debt where interest rates are often much lower than local rates, this could really become a problem over the next 2-3 years as new issuance or refinancing becomes necessary. An alternative view is that perhaps this is a coordinated policy intervention, something of a reverse Plaza Accord when the dollar was devalued back in the mid 1980s. This time the shoe is on the other foot where the weakening of currencies from a number of export driven economies may bolster their competitiveness and jump start their growth, it’s just unlikely to have much of an effect when global growth is declining and a recession seems likely if not inevitable. Maybe this does pay off down the line. There is also the possibility that the Fed’s hawkish stance to slay inflation is providing cover for the central banks across the world that had been using negative interest rates policy to get back into positive territory nominally at least. Clearly ultra-cheap money abroad did not lead to higher growth rates, in some reverse logic maybe higher rates will create a sense of urgency and provide a healthier level of inflation after we get through this current bout. 


3. Since last November when the real “Powell Pivot” occurred and comments from the Fed became more hawkish with the forthcoming end to quantitative easing and set the table for raising rates, markets have pricing in higher yields on the short end and we did see some effect on the long end too.  Recall the 10-year Treasury started the year at about 1.50% and closed Friday at 3.70% up 220 basis points, a sizable move though not quite historic in an absolute sense. But longer-term rates had stalled out in June until this week’s spike higher. The prior narrative had been that short term rates best express the Fed’s hawkish current policy, if they continued on the current trajectory they were bound to break things leading to a recession and thus slower growth and lower inflation in the future. If that were to be the case then a lower yielding long bond seemed perfectly plausible. Recall that inflation for the 10 years prior to the pandemic averaged just short of 2%, add a little term premium for the duration and you get to a yield between 3-3.50% very much in line with the rangebound trading the last few months. But now with the long end moving higher, is the belief that in fact growth may be a little north of the long run trend given the economic resiliency here in the States ? Or more likely have the bond vigilantes finally taken their shot at the market with a buyers strike right when quantitative tightening ratcheted up this month. With the Fed allowing even more securities to roll off their $9TT balance sheet, a big buyer has stepped away thus sapping about $95BB worth of demand out of the market, $60BB of Treasuries and $35BB of MBS. If stocks were going to struggle to justify valuations with earnings fading, contending with higher rates then becomes further weight to the tape. Just as I am reluctant to attempt to predict the short term direction of the stock market I am going to refrain from sticking my neck out here as well. 


So what is an investor to do…

  • Stick with your asset allocation strategy, if at the margin you want to make adjustments that’s fine but don’t get caught trying to market time. You’ve already taken a good punch, in theory the time to sell was back at the all-time high in January. 
  • For those of you willing to be a bit more opportunistic market dislocations can create opportunities, perhaps you have some money sitting on the sidelines with the intention of investing , it may not be a bad time to put to work slowly, perhaps using a dollar cost averaging approach for the next 3-6 months. With the VIX just shy of 30 there is some palpable fear our there which usually means the market is a bit oversold and bargains can be had. 
  • We all have some cash sitting around likely getting hardly any interest, you can buy 6-month Treasury bills yielding not too far from 4% (3.86% at Friday’s close.) If you don’t mind extending duration, laddering out 6, 12, 18 & 24 month investments likely gets you to 4% on average and if rates do start to go back down in late 2023 or early 2024 you’ll feel a little better having locked in those higher rates for a little longer. If rates keep going up that’s just fine, you’ll have money available to reinvest as the short-term maturities in your ladder come due. Keep in mind for those of high-income tax states Treasuries are exempt from state taxes. There are also some attractive blue chip companies with yields between 4.50-5.00% going out anywhere from 1-3 years and offering a little more if you extend duration 4-6 years out and municipal bonds are starting to look cheap interesting too. 
  • Consider a Roth conversion, with asset prices depressed you are able to convert roughly 125% of the amount of shares you would have back in January, I understand the idea of paying more in taxes may feel like adding insult to injury, but this is likely to pay off if you have a holding period of 10 years or more for the Roth
  • Rather than wait to fund your Health Savings account or Roth IRA for 2022 up until April 2023 now may be a good time to make those contributions 
  • Harvest tax losses wherever possible, given the market volatility and investor outflows many mutual funds will likely make sizable distributions in the 4th quarter despite the fact the fund lost money this year, this phenomenon is the result of fund managers needing to sell securities to cover client redemptions resulting in the fund realizing gains that had actually occurred over the last 10+ years


Remember markets are discounting systems, they will turn far earlier than the actual economic data seems to suggest. Legendary investor George Soros has talked about the concept of reflexivity and this theory seems rather evident today where price action is having as much influence on markets or economy than the other way around. Quoting Soros, “I can state the core idea in two relatively simple propositions. One is that in situations that have thinking participants, the participants’ view of the world is always partial and distorted. That is the principle of fallibility. The other is that these distorted views can influence the situation to which they relate because false views lead to inappropriate actions. That is the principle of reflexivity.” Perhaps more simply stated markets tend to be dislocated from the equilibrium that defines efficient markets more often than not. This is the result of human beings’ tendency to overshoot assuming that the good days will never end or alternatively that this is the crisis to end all crises and that the sky is truly falling. It’s hard to quantify how much of the selling is a result of the selling and lower prices that have already occurred. It’s not until investors have exhausted themselves with the selling (or buying when exuberance sets in) that markets can drift back towards their real fair value. Along those same lines Nobel Prize winning behavioral economist Richard Thaler has written about the irrationality of the human actors that are everyday market participants in two of his great books “Nudge” and “Misbehaving”. His reasoning is that if the planet were filled with emotionless characters like Star Trek’s Mr. Spock, referred to as “Econs” , markets would likely oscillate a lot less than they do. That seems wonderful right about now, but you’d likely have to forgo the equity risk premium and sacrifice some of that excess return. Stay patient and humble and you’ll be okay in the long run.  It’s hardly a perfect system, but it has its advantages and surely better than the alternative systems in place.


Thank you for letting me occupy some of your valuable time!


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The enclosed content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice. Nothing contained within constitutes a solicitation, recommendation, endorsement, or offer by Breakwater Capital to buy or sell any securities or other financial instruments or offering in this or in in any other jurisdiction. You alone assume the sole responsibility of evaluating the merits and risks associated with the use of any information contained within before making any decisions based on such information.


 Source: Data/Statistics from Factset, Bloomberg, JP Morgan Asset Management

Breakwater Team

At Breakwater Capital, we work with families across the United States, providing each client with a personalized experience tailored to their current circumstances, future goals, and timelines.

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A return to earnings growth was a welcome driver of higher stock prices, though truthfully much of the increase in the 2+ years since the bear market trough has come from multiple expansion. What makes that particularly interesting is that this is in spite of higher interest rates, where there attractive sources of alternative return would typically be a net negative for equities. Let’s be clear, higher valuations do not necessarily need to reset back to historical levels though that’s entirely possible. It is reasonable, however, to assume richer prices will impact future returns and leave little margin for disappointment when it comes to the data, whether we are speaking about the macroeconomic backdrop or idiosyncratic factors impacting individual companies. All this is meant to suggest the merits of diversification, which can and should be used as a tool to both possibly augment returns or reduce portfolio volatility. The early indications here in 2025 are illustrating those benefits. The MSCI EAFE index, the S&P equivalent for the developed markets outside the US, is up nearly 8%, perhaps finally looking to close a wide performance chasm that occurred over the last 15+ years. Similarly, bonds have offered a port in the storm, as the Bloomberg US Aggregate Bond Index is up about 2.50% year to date. More on the topic of bonds… As we spend the early part of the year commiserating about the news of premium hikes for our health, auto or homeowners’ policies it is not uncommon for us to question the value of those policies, especially when year after year we go without filing a claim. Insurance has been resigned to being a necessary cost to avoid a financial catastrophe in the face of some adverse event, but I am not sure it is appropriate to share the same perspective about portfolio insurance. There are a variety of ways to protect one’s portfolio from raising cash, to using structured products or derivatives, but as the saying goes the only free lunch in investing is achieved through diversification. 60+ days into 2025 spreading out your bets is paying off with the vaunted Magnificent 7 down about 8% while many other areas are positive if not materially positive in that time. Sure, we have seen a number of head fakes over the last 4-5 years where the luster was seeming to wear off only to see these hyper-scalers find their footing and catch investor’s fancy, but all good things must come to an end eventually. Whether or not that’s 2025 or at some point in the future, we’ll need to wait and see, but do not expect me to keep wagering on a handful of expensive stocks alone. The capital markets are vast and deep, odds are when we reflect back in 5-10 years the top performing assets likely will surprise us. With a 5-year annualized return of -.62% for the Bloomberg US Agg, it is understandable why investors may be disinterested in this asset class. Stocks on the other hand, as measured by the S&P 500, have averaged 15.15% over the same period, that’s a nearly 80% difference and if history was to consistently repeat itself it would be fair to ask yourself what’s the point in owning bonds. However much like car insurance or homeowners’ insurance they are there to provide some real value (protection) should something calamitous happen to the stock market. What’s unique here is that typically insurance, comes at a cost, in the form of a premium, but with bonds you actually get paid (interest) while you are holding them and the real downside is opportunity cost or foregone returns, which seems a lot better than a premium payment for a claim never filed or a 20% bear market for that matter. Back to the present, in the aftermath of the 2024 election, markets reflected an optimistic tone regarding President Trump’s return to the oval office. The thinking mainly focused on a pro-growth agenda where regulatory relief and further tax reform would support asset prices. While questions remained about the impact of tariffs and immigration policies, the administration was given the benefit of the doubt that any approach would be measured and hopefully well telegraphed. Now roughly 40 days into his second term, the President has issued innumerable executive orders, some of which will be challenged in court while the impact of others still needs to be flushed out and the rhetoric on tariffs has been far more bombastic when it comes to historic allies and perhaps less onerous on China where much of the political capital and energy was spent in 2017-2018. On balance, tariffs are a net negative as the costs are born by the importing country, possibly contributing to inflation at a time when there is little appetite for higher prices. A country that historically espoused the merits of free trade would be best served to limit tit for tat trade policy and instead source goods from nations that have been more aligned with our interests. In the end I am hopeful this ends up being about negotiating leverage rather than the start of something more painful for consumers and workers who likely would feel the second order effect of waning demand or strained budgets. While perhaps well intentioned, the fact is other countries may very well have ample capacity to ride out any policies that they find detrimental to their own economies. DOGE and the microscope on spending. Over 60 years ago, Lyndon Johnson who campaigned on the notion of the Great Society introduced legislation that created Medicare and Medicaid, the formation of the U.S. Department of Housing and Urban Development and Head Start among others embarking on a journey that would see the government’s role in society expand exponentially. These programs added to the social safety net that was initially created in the aftermath of the Great Depression where Social Security and the Supplemental Nutrition Assistance Program (SNAP) were born. In general, these programs have grown far faster than the rate of inflation, in some instances crowding out the private sector and creating ample opportunities for mismanagement, whether intentional or otherwise. To their credit, both Ronald Reagan and Bill Clinton instituted policy priorities to right size these programs, but other administrations have been willing to grow entitlements with little consideration to demographic dynamics, incentives or the capacity to cover these costs which eat up more and more taxpayer dollars with less and less accountability. The United States with a budget of $7TT, of which $2.8TT is attributed to deficit spending, finds itself with 60%+ dedicated to mandatory spending which is comprised of interest on our debts, some veterans benefits and the aforementioned Medicare and Medicaid programs along with Social Security. Discretionary spending, which makes up the difference, is where you’ll find defense spending as well as outlays for education, transportation, science, foreign aid etc.… We can all agree that any opportunity to eliminate waste or fraud or for programs that have limited benefit to our interests abroad should be heavily scrutinized and eliminated. Assuming a more measured approach around enacting reform should be welcomed and will likely have a positive impact on the economy and the markets in the years ahead. The public seems comfortable with the idea of reviewing expenditures, but the “move fast and break things” approach has been unsettling as witnessed by recent poor readings on consumer sentiment from both the Conference Board and University of Michigan monthly read outs. The irony of the “tough on everyone” approach, including our allies, may result in invigorating economic regions that have been prone to bouts of sclerosis. The Europeans seem particularly rallied around the idea that the United States sense of elitism is misguided which could foster some healthy competition though it could foment some ill will towards Americans and their corporations. The combination of less demanding valuations, more space for fiscal and monetary stimulus along with something resembling animal spirits would go a long way towards creating synchronized global growth which we have seen on a few occasions in the last several decades. Assuming you see something of a détente with China later this year so long as they allow for some modest currency appreciation and fiscal stimulus it could be off to the races for foreign stocks. Lastly, on the topic of interest rates, the real cost of money after all, the next few months will be rather interesting to watch unfold. March offers the February Nonfarm Payroll Report and a Fed meeting with the updated Summary of Economic Projections (SEP) where the possibility exists that they may shift from a slightly more hawkish posture to a more balanced tone, hinting at 3 rate cuts for this year, which would be well received. We are still likely 6-7 rate cuts or 1.375% away from neutral, but far less restrictive than we were just 6 months ago. If rates do head back down in an orderly fashion, it’s hard to envision a scenario where that’s not modestly bullish for risk assets. Away from short-term rates, which are really driven by Central Banks, Treasury Secretary Scott Bessent has been talking about the efforts to bring the 10-year Treasury yield lower. The rate has dropped about .50% since the start of the year though perhaps the fact that it’s been a somewhat rapid decline has served to spook the market somewhat as after all the bond market has been considered the smart money versus the stock market but we won’t get into that today. Since the 10-year rate has more influence on long-term borrowing costs, including mortgage rates, it was welcome to hear that there is extra attention there, though government policy is only one component of the pricing behind that security. If rates remain rangebound this year somewhere between 4-4.50% it bodes well for the economy and markets, rates falling too sharply would likely be the result of a risk of trade perhaps related to an exogenous shock and rates going too high (5%+) would start to put more pressure on equities and high yield bonds. To come full circle, there is a lot going on and perhaps a bit more uncertainty than would be the case with a newly elected administration that controls both chambers of Congress. Until there is further policy clarity and businesses are able to show their ability to grow earnings and improve margins, we would be well served to prepare for more volatility than we experienced in the last couple of years. Over the last 25 years the average intra-year decline for the stock market has been 15.4% so while we will not ask you to enjoy something like that we should be prepared for the possibility. Diversification seems like as good of a tool as any to provide you with a little insurance if there are a few more bumps along the way. Sources: WSJ, Barron’s, AMG, FRED

The Impact of Rising Interest Rates on Retirement Planning

By Breakwater Team • February 7, 2025
It may seem like the last 3-4 years have seen a business news cycle dominated by all things interest rates. There is no doubt the “cost of money” is critically important. Rising Interest rates can create both opportunities and risks for your retirement planning. Higher borrowing costs and market volatility may impact portfolio returns and income strategy. Understanding how these changes affect your retirement is key to making informed decisions.  At Breakwater Capital Group , we bring over five decades of combined experience managing financial assets for individuals and families with diverse goals, even in shifting economic conditions. We proudly serve clients nationwide through our Massachusetts, New Jersey, and Colorado wealth management offices. This article discusses how changing interest rates influence various investments and outlines actionable strategies to consider for your retirement planning.