2022 has been a rare year in the markets as both stocks and bonds are down simultaneously. The second quarter was tumultuous as global markets battled with stubbornly higher prices, continuing supply constraints, cooling economic data, and elevated interest rates. Stateside, the Federal Reserve took decisive action in their attempt to curb the strongest inflation reports seen in decades by raising interest rates in an accelerated fashion, increasing the policy rate by 0.75% in June alone. The Russia-Ukraine conflict and aftermath of China’s Zero-Covid policy restricted supply of their respective goods, contributing to elevated inflation concerns and declining economic growth expectations. High global energy costs added to these upward price pressures which increased uncertainty on the earnings picture and recession fears. Given this uneasy backdrop, returns across markets and sectors were broadly negative.
Q2 2022 Market Commentary
Domestic equities continued their decline as investors focused on inflation and tighter policy response out of the Federal Reserve. It finished off as the worst first half to start the year since 1962 as the debate of a soft or hard landing for the economy raged among market participants. The Fed is trying to strike a balance between bringing record-high inflation down without triggering a recession in the economy as they raise interest rates. As we have said in the past and looking historically, this is an enormously difficult task. Over the quarter, US economic data was robust but showed major signs of a slowdown beginning to emerge. While unemployment, a lagging economic indicator, remained low and wage growth strong, consumer sentiment fell to all-time lows. Inflation, which stood at +8.6% YoY, and higher interest rates dampened once strong consumer spending habits and caused households to draw down savings. Higher interest rates effect all levels of the economy but especially in the housing market where 30YR fixed rates have gone from 3% to 6% in the matter of months, making home ownership much less affordable. This relationship showed up in existing home sales which declined for the fourth straight month. With first quarter GDP already negative, if the second quarter print comes in below zero then, by the technical definition, the US will officially be in a recession. All sectors finished in the red. The outperformers were in the defensive groups like Consumer Staples (-4.9%), Utilities (-5.8%), and Healthcare (-6.4%). Growthier areas of the market like Consumer Discretionary (-25.7%) and Technology (-20.0%) underperformed. The S&P 500 declined 16.5%, the Dow Jones Industrial Average fell 11.3%, and the tech heavy NASDAQ lost 22.4%.
Equities in the eurozone fell across the board to due similar problems facing many developed nations. Like the US, the Eurozone is worried about how higher interest rates will affect the economy. Consumer confidence fell to the lowest level since the early stages of the pandemic as recent business activity suggests a small chance that the bloc escapes a recession this year. Ongoing elevated inflation (+8.6% YoY) caused the European Central Bank to finally act as they are set to raise rates for the first time in 11 years at its meeting this month. The central bank said it would hike again in September, meaning its interest rate could return to positive territory in 2022 – the ECB has had negative rates since 2014. The biggest worry investors share concerning not only the ECB, but central banks globally is hiking rates and hampering economic growth at a time when the slowdown is already underway. What’s more is the war in Ukraine causing increased uncertainty over potential gas and food shortages which could send the region into a slowdown earlier than expected. UK equities fell during the second quarter as large cap companies held up well, especially in the defensive space. Overall, recessionary risks weighed on markets causing consumer discretionary sectors to perform extremely poorly. On the monetary front, The Bank of England implemented its 5 th straight rate hike near the end of June which brought its policy rate to 1.25%. The latest inflation print came in at 9.1% YoY as soaring food and energy prices continued to deepen the country’s cost-of-living crisis. iShares MSCI United Kingdom fund fell 10.9%.
Though EM outperformed developed markets, a stronger dollar weighed on the index as it fell 11.2% in Q2. Many of the Latin American countries like Brazil (-27.6%) were among the weakest of the index due to the combination of policy uncertainty, weaker industrial metal prices, and rising global growth fears. China was a bright spot and the only country to have a positive return over the quarter. Easing of lockdown measures and better economic data helped ease investor uncertainty. The iShares MSCI China fund was up 5.5%.
The Federal Reserve continued its hiking cycle in an extraordinary manner, raising interest rates by 1.25% during the quarter. They have made it clear via both public discussion and aggressive action that managing inflation is their primary concern and are willing to increase the probability of recessionary consequences to do so. The Fed also initiated quantitative tightening to begin reducing their balance sheet and further push towards restrictive monetary conditions. These actions, along with inflation fears, forced yields higher, spreads wider, and bond prices deeper into negative territory across all sectors of the fixed income market. The Bloomberg U.S. Aggregate Bond Index was down 5.1% in the quarter. The high yield market, which is more cyclical in nature than core bonds due to the lower credit quality of its constituents, fell 10.6% on fears of increased default rates.
After a turbulent first quarter, oil markets followed up with another volatile period. Despite reaching a staggering $122 a barrel in mid-June, WTI Crude finished the quarter at $105 to return 5.5%. The war in Ukraine and other supply related issues that had driven the price of oil sky high were tamed by recessionary worries that reduced demand expectations. Data pointing to a slower economy (i.e. one with less need for oil) brought prices down to more recognizable levels. Agricultural products (-6%) were down broadly with Wheat and Cotton at the bottom of the heap. Precious metals also sharply fell due mainly to the Fed-induced strength of the dollar and rising real yields. Gold and silver lost 6.7% and 18.2% respectively. Due a combination of higher interest rates, elevated inflation, recessionary risks, and most importantly, a loss in speculative market behavior, Bitcoin (-59.1%) lost over half of its value in the second quarter alone and finished below $20,000 for the first time since December of 2020.