November 27, 2022

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Lear Capital’s Founder Explains Why Today’s Stock Market Is So Volatile 

To say that 2022 has been a topsy-turvy year for the stock market is an understatement. There is a confluence of factors creating the volatility. Economic specialist Kevin DeMeritt analyzes the reasons investors are seeing sizable highs and lows.

During the first half of 2022, the market experienced significant declines, with the S&P 500 dropping more than 20%, the Dow Jones Industrial Average falling more than 14% and the Nasdaq plummeting more than 28%.

By the end of September, all three markets had fallen more than 20% from their high points, officially becoming bear markets, according to NPR; the S&P 500 produced its worst performance for the first nine months of the year in more than two decades, the Nasdaq had slid more than 30%, and the Dow negated essentially all of its gains from the previous two years.

The stock market is currently feeling the aftereffects of previously strong economic activity, which was partially fueled by $22 trillion in currency produced between 2008 and today, says Kevin DeMeritt, founder and chairman of Los Angeles-based gold and precious metals firm Lear Capital.

“When you print that much money, it’s going to go somewhere — and once something starts getting momentum, like the stock market, it just continually goes up,” DeMeritt says. “You get stock margin debt at incredibly high levels, and then the Fed starts raising interest rates. [People say,] ‘My margin debt, my home costs me a little bit more; let me pull a little bit out of the stock market.’ That starts to bring it down. Then they raise [rates] a little bit more, and we’ve got to pull a little bit more money — that’s what causes volatility.”

Several specific factors have influenced the stock market this year — ranging from federal rate policy actions to foreign disputes — including: 

Inflation — Since the spring of 2021, inflation has been increasing; the consumer price index for all urban consumers notched up 0.6% in March 2021, marking its biggest one-month increase since 2012, and by June of this year, the index had risen to 9.1%, its highest point since 1981.

With demand for products still high in the U.S. and supply chains still struggling to overcome labor and other issues, in August 2022, the most recent month for which data has been released, inflation remained high, with the consumer price index at 8.2%.

“The definition of inflation is too much money chasing too few goods,” Kevin DeMeritt says. “After COVID, we have a supply chain problem. The Fed has printed so much money it feels like there’s too few goods, but there’s the same amount of goods actually out there — it’s just prices are going higher because you have too much money chasing those goods.”

The Lear Capital founder says the increased costs consumers are paying for goods and services have undoubtedly had an effect on investor appetite.

“It’s been a long time since we’ve had this kind of inflation,” Kevin DeMeritt says. “We’re starting to see more and more people become concerned about the volatility in the stock market — which happens when you have high inflation.”

Interest rates — In an attempt to quell escalating inflation, the Federal Reserve has enacted a number of rate hikes this year to slow the economy.

In March, the organization’s Federal Open Market Committee raised the target range for the federal funds rate to 0.25% to 0.50%, and again increased the rate range at its May meeting to 0.75% to 1%. In June, the FOMC again upped the federal funds rate’s target range to 1.5% to 1.75% — the largest increase since 1994; in September, it raised it again to 3% to 3.25% and in October, increased it to 3.75% to 4%.

While some elements appear to indicate things might be moving in the right direction for inflation to decrease — including Commerce Department data that showed the economy had shrunk in the second quarter at an annual rate of 0.6% — inflation remains considerably above the Fed’s 2% target goal. The central bank’s current interest rate projections are 4.4% for the year, and it has estimated in 2023, interest will be 4.6%.

Anticipation surrounding the FOMC possibly raising rates at some point this year — and the resulting anxiety when it did — could have prompted some investors to look for seemingly less volatile ventures.

As such, the Fed’s recent rate hikes may have made Treasury bond yields an increasingly attractive option. Because the bonds’ low-risk nature makes them a generally safe, yet not necessarily high return on investment vehicle — particularly if the term is short and would provide a smaller payout — investors might, in the past, have opted for stocks that would likely supply a bigger return. 

Even before the rate increases began this year, Treasury yields started to rise — indicating, according to The New York Times, that the bond market anticipated interest rates would soon be adjusted. Currently, government bonds are providing 4% to 6% payouts in some instances, according to an October NPR article.

Russia’s invasion of Ukraine — Because both countries are substantial exporters — Russia is a key energy commodities and precious metals provider, and Ukraine produces large amounts of food items, including wheat — the ongoing conflict has caused considerable uncertainty about a number of potential supply issues.

After Russia’s military began trying to seize Ukraine in late February, food and energy price increases, according to the Federal Reserve Bank of St. Louis, were notable by early March as it became clear the conflict wouldn’t be resolved quickly and sanctions were likely to be imposed on Russia. While the shortages physically affected European nations that more directly depended on commodities, food, and other items from Russia and Ukraine, financial markets felt the effect globally. 

With spot gold prices — a term generally used to describe the price of 1 troy ounce of gold within global gold markets — at one point in March exceeding $2,000, investors, possibly seeking a reprieve from the market instability, embraced gold-based investing this year, which is often viewed as a safer commodity during ambiguous periods, according to U.S. News & World Report. 

“Gold has an inverse relationship to stocks and other types of assets, so in times of war or terrorism, usually you’re going to find the markets become extremely volatile,” Lear Capital founder Kevin DeMeritt says. “If [Russian President Vladimir] Putin today said, “Hey, I’m done; I’m going to pack up my stuff and go home,” the markets might skyrocket. Then again, if something like nuclear weapons comes up, the market drops 500 to 1,000 points. The volatility of gold is not going to be the same as what we’ve seen with the war, 9/11 or this inflation situation [in] the stock market.”

Because gold can potentially provide stability during uncertain times, investors could potentially gain some protection against future conflicts’ impact by adding it to their investment portfolio.

“What we’re seeing in Ukraine could happen in Taiwan [or another country],” Kevin DeMeritt says. “You can’t predict those things, but when they happen, it can have a devastating effect on investments — especially if you’re retired [and living] on your assets. Let’s have a hedge on the other side that will help you in those dark days.”

Risk of a recession — Concern that a recession is imminent can cause investors to pull back on their participation in the market in an attempt to curb future losses. There have been signs the U.S. could be headed toward one — including more than one yield curve inversion, which occurs when short-term yields rise above long-term yields.

The 2-year Treasury yield and 10-year yield have been inverted since July; the 3-month yield and 10-year yield inverted on Oct. 25 and 26.

A yield curve inversion involving the difference between the 10-year and 3-month Treasury rates has occurred before every recession since 1960, according to the Federal Reserve Bank of New York.

While factors such as federal stimulus payments and lower interest rates may have allowed a number of Americans to build up monetary reserves during the pandemic and continue to spend, the evolving economic climate — particularly if we slip into a recession — could soon change that, according to Lear Capital’s Kevin DeMeritt.

“There’s going to be a lag because that money’s still sitting around, but slowly but surely through inflation, the purchasing power drops; through higher interest rates, your bills go up — so it’s going to evaporate pretty quickly,” DeMeritt says. “That’s why they’re saying 2023 is going to be the year of the recession.”