The American stock market dropped in the 3Q 2022, due to the Fed’s interest rates hikes and elevated inflation concerns.

The American stock market declined by 5.8% in the 3Q 2022, as the Fed has continued to raise interest rates in line with elevated inflation concerns. Fed’s interest rate is currently at 3.25% to 3.50% range, much higher than the 2.50% before the pandemic. Last time interest rates were this high was before the financial crisis in 2007/2008 at about 6.00%.

Meanwhile, inflation continued to be high at 8.2% in September 2022, but has started to ease from its peak of 9.1% in May 2022. The high inflation was driven mainly by higher global commodity prices especially crude oil and natural gas due to the continued Russia-Ukraine conflict. This could be exacerbated by the OPEC plan to cut crude oil production by 2m barrel starting November, causing crude oil prices to rise again.

The weaker performance was driven by the real estate, telecommunications, consumer discretionary, technology and utilities sectors.

It shouldn’t come as a surprise that the real estate sector will be heavily affected in this high interest rate environment. Higher interest rate means that homebuyers will find it more expensive to borrow money to purchase houses. Real estate companies who depend heavily on loans to build properties also face higher debt burden. Meanwhile, the telecommunications sector decline was led mainly by media companies corporate earnings being weak and disappointing. Netflix in particular, suffered from weak profits amid a loss in Netflix users and subscription revenue.

Amid the high inflation environment, consumer discretionary sector declined as consumers hold back on spending as cost of living increases. On the other hand, the technology sector suffered from increased profit taking as investors pulled back on risky investments amid a flight to safe-haven assets and the recent ban on semiconductor exports to China. Finally, the utilities sector while they could charge higher prices for electricity, suffered from decreased consumer confidence amid the high inflation environment also.

The bright spot in the U.S. market came from the energy, industrial, material and financial sectors.

The energy sector benefited from high prices for crude oil and natural gas as the U.S. is the biggest producers of crude oil and natural gas in the world. With OPEC planning to cut crude oil production by 2 million barrels per day starting November, crude oil and natural gas prices are expected to rise further moving forward. The industrial and material sectors did not decline that much, as they were supported by elevated commodity and material selling prices previously.

Meanwhile, for the financial sector, higher interest rates provided a lift in corporate revenue and profits for the banking sector as they were able to charge higher interest rates on existing and current loans.

The outlook for the U.S. market does not look that great moving forward, with high inflation and interest rate hikes continuing to be major concerns.

The U.S. market’s earnings are still expected to grow at a steady rate of 13.5% in 2022, slightly lower than the 14% annual growth from the past 3 years. However, this is subjected to significant downside risks arising from the continued high inflation in the U.S. amid elevated global commodity prices and interest rate hikes that could plunge the U.S. economy into a recession.

By sectors, investors are very positive on the sectors consumer discretionary, telecommunications, industrials, and healthcare with earnings per share growth forecast of above 10%. Meanwhile, the energy sector is expected to register declining earnings per share growth due to the high base in 2022.

The U.S. stock market is currently trading at below the historical price-to-earnings ratio, indicating the negative sentiments of investors on the market.

U.S. companies are trading at a price-to-earnings ratio of 22.1 times compared to the 5 year historical average of 30 times. While this could present an opportunity to accumulate stocks that are undervalued, this is only valid for companies who have dominant positions in their own respective industries and strong financial health.

Negative sentiments is still prevalent in the market mostly, and pe ratio was actually significantly higher than historical average during the pandemic. This could mean that investors were overbullish during the good times and they are now finding themselves correcting their investment decisions into safe-haven assets.