Quarterly Update

The second quarter of 2022 (Q2) was one that most investors were anxious to put behind them as it rounded out the worst first half of a year for stocks in five decades. Inflation, Federal Reserve policy decisions, and recession fears supplanted Russia’s February invasion of Ukraine as the key issues for markets. And as sentiment followed stock prices down throughout the quarter you had to squint to see the few bright spots along the way.

Here’s a roundup of how major markets performed during Q2 and year-to-date, respectively:

• US Large Cap Stocks: down 16.1%, down 20%
• US Small Cap Stocks: down 17.3%, down 23.5%
• US Core Bonds: down 4.6%, down 10.2%
• Developed Foreign Markets: down 13.2%, down 18.8%
• Emerging Markets: down 10.4%, down 17.2%

Stock prices around the world fell during the first quarter, but declines accelerated during Q2 as risk assets in general were hit hard. Bitcoin and other digital assets suffered major losses due to overall risk-off sentiment and some heavily-levered (and simply ridiculous) portions of that market fell apart. US Large Cap stocks as measured by the S&P 500 entered a technical bear market (a 20+% decline from a recent high) during Q2. Losses came quickly with multiple stretches of back-to-back 1% - 3% declines and a 10+% drop during one week in June. The tech-heavy NASDAQ 100 ended the quarter down about 28% year-to-date, with most of that decline occurring in Q2. Within the various market sectors, Communication Services and Consumer Discretionary put up the poorest showing, down about 23% and 26%, respectively, for the quarter and 30% or so year-to-date. The only positive sector in the US has been Energy, up around 31% year-to-date while still posting declines of about 5% during Q2.

Driving much of the poor performance was evolving concerns about inflation and how the Fed would react to it, continued pandemic-related supply chain and commodity markets disruptions due to Russia’s invasion of Ukraine (which helped the Energy sector), and the interconnectedness of it all potentially leading to a recession.

Inflation hit 8.6% during May, a multi-decade high, with prices for housing, gas, and food the largest contributors. This price surge kicked into gear last October but really caught up with markets and the Fed during Q2. Some miscommunications about the perceived seriousness of the inflation problem accompanied two rate increases from the Fed, 0.5% in May followed by 0.75% in June, the largest increase since 1994. During Q2 the Fed reaffirmed (or shifted gears, depending on your perspective) that its first job, maintaining stable prices, is required to handle their second job of maintaining full employment within the economy. The Fed’s primary method for tempering inflation is to slow the economy by raising interest rates, a blunt tool that is tough to wield without triggering a recession. Investors grappled with this during Q2 without any meaningful resolution as the quarter closed. Accordingly, the aforementioned few bright spots occurred around soothing words from the Fed about future rate increases or data showing an economy already slowing, implying the Fed could raise rates less aggressively and be less likely to make things worse.

Bond prices fell less in Q2 than during the first quarter and provided some support to portfolios but were still volatile due to the same issues impacting stock prices. The broad bond market fell about 4% during Q2 and is down about 10% this year. Bond yields rise as prices fall and the 10yr Treasury yield, a key benchmark, rose to 3.6% before closing out the quarter at about 3%. This caused the average 30yr mortgage rate to briefly hit 6.3% before backing a bit as Q2 ended – but still almost double where it was just six months ago. These rapid changes in bond yields and the cost of borrowing act as roadblocks for inflation but could also help spur a recession.

The outlook was mixed for much of Q2, and little clarity exists as we begin the second half of the year. A variety of economists and market watchers continue to scratch their heads at the odd juxtaposition of data showing continued pent-up demand for certain goods and services in our economy and a strong job market, coupled with declining consumer sentiment and confidence about the future. Most economic indicators seem to be telling us that we’re not in a recession now, while some appear to be rolling over. And the inflation problem was showing some potential signs of moderating as we closed Q2. All this complicates any clear narrative about the near-term path for growth. In short, the economy isn’t following the typical playbook and this, perhaps in hindsight, should have been expected after such a tumultuous period.

Numerous market sentiment surveys were flashing red as we ended Q2. For example, a survey from the Conference Board found that only 26% of respondents expected higher stock prices a year from now, a ten-year low. In light of this it’s understandable that some retail investors have been throwing in the towel. But history shows that such poor sentiment usually leads to strong returns a year out and is why such survey results are viewed as a contrarian indicator. For us, amid continued uncertainty the main job continues to be ensuring our portfolios are set up correctly, rebalancing as needed, and buying stocks and bonds on weakness as appropriate. This isn’t much fun during times like these, but the decisions we make today will absolutely impact our tomorrow.

Have questions? Ask me. I can help.