To say the state of the market has been volatile may be fair or understated. Year to date, the S&P 500 and NASDAQ 100 have declined by as much as 20% and 30% respectively in one of the toughest 1H stock market performances in a handful of decades. Although as private investors we’re relatively more shielded from the day-to-day volatilities in public markets, we know the performance of public markets will ultimately affect our private investments’ exit outcomes.

What Happened: Naturally, we’re searching for answers as to what happened and where we may go from here. Here’s our simple version of the consequence of events: imbalances in the economy coming out of a shutdown and restart -> 40-year high inflation -> the Fed under Congressional mandate raises the policy rate aggressively to slow economic demand in hopes of calming down price increases -> Fed’s policy rate is a significant input into the cost of capital -> when cost of capital rises, stock prices fall because cost of capital is the denominator in the mathematical equation to value stock prices. In hindsight what’s happened year to date across the stock market is not illogical.

Fed Policy: Logically if inflation is a root cause of economic and market volatilities then one would argue that if the root cause goes away then the symptoms may begin to dissipate and the markets may finally begin to stabilize. Thus within the economist and market strategist community inflation has become probably the most important economic data point to watch. According to our research, a good way to track inflation in real time – and the way the Fed and the FOMC may look at it – may look something like this. There are 3 major ways the Fed analyzes inflation on a month-to-month basis. Analogously, it’s like how a doctor may monitor a patient across the temperature, the heart rate, and the pulse.

Outlook: In the above is a matrix across the few categories of inflation indicators across a time series, where each indicator measures a different part of the economy: the consumers, the businesses, the markets, and the outlook. The Fed/doctor is looking for consistent inflationary declines/improvements in vitals in order to change policy/prescriptions. The word ‘consistency’ in this context means at least two consecutive months of decline. The good news is that starting in the June 2022 data we’re seeing moderations in inflation (e.g., PCE declined, the financial market-based measures became more anchored to the 2-3% long term inflation averages). The bad news is that these data points come out once a month. And the set of July 2022 data won’t come out till the following month, and so forth. So we won’t know till August whether we’ve seen a consistent decline in inflation. But once the data establishes that trend, then we think the Fed/doctor may begin to react accordingly. Sometimes in 2H 2022 – in our view – should mark the bottoming process for the stock market. This means valuation multiples may begin to stabilize, and next year may be a better year for the market. Fingers crossed.