Updated: Jan 9
Jayson Moss, CFA Chief Investment Officer
U.S. markets declined significantly in the second quarter of 2022 following weak first-quarter returns. This is the weakest first half of the year for equity markets since 1970 when the S&P 500 decreased 21%. The first six months of 2022 also saw the steepest selloff of bonds in 40 years, with long-date treasuries declining over 10% on a total-return basis, something that has not been seen since 1980. Over the same period, crypto currencies plummeted, while technology stocks posted abysmal returns. All told, there was nowhere for investors to hide.
Since the start of 2022, a number of unanticipated factors have combined to cause a risk-off trade globally, with most asset classes declining in the first two quarters of 2022 and investors considering reducing their exposure to market risk and moving to an emphasis on preservation of capital. These surprises included the advent of the COVID-19 Omicron BA.4 and BA.5 variants early in the first quarter, continued pandemic lockdowns (particularly in China given the country’s “zero COVID-19 policy”), the continued conflict caused by the Russian incursion into Ukraine, and inflationary pressures that have not been seen in over four decades. Slowing global economic growth and tightening monetary policy have investors concerned that a recession is around the corner, and global markets reacted to a significant sell-off in the second quarter.
During Q2 2022, the S&P 500 Total Return Index declined 16.1%, while the tech-heavy NASDAQ Composite Index (price return) decreased 22.4%. Year to date, the S&P 500 Total Return Index is down 20.0% and the NASDAQ has decreased 29.5%. Global Equity markets experienced similar declines. In Canada, the S&P/TSX Composite Total Return Index decreased 15.7% in the second quarter of 2022, while in Europe the MSCI EAFE Index Price Return was down 15.4% for Q2 2022.
Commodities also performed poorly in the second quarter as the futures prices for copper and gold decreased 21.7% and 7.4%, respectively. In contrast, given the ongoing conflict in Ukraine, oil and gas prices were up markedly in the first half of the quarter, with oil futures (NYMEX) peaking on June 8, 2022 at US$122.11 per barrel and natural gas futures
(NYMEX) hitting US$8.97 per unit on May 25, 2022. Both commodities have since retreated from their highs, with the price of oil ending the second quarter at US$105.76 per barrel (up 5.5% for the quarter) and the price of natural gas falling to US$5.42 per unit (down 3.9% for the quarter).
Acting as an additional headwind, inflation is running at its fastest pace since December 1981. In May, the US Consumer Price Index increased by 8.6% year over year. Prices for all consumer goods and services have increased; however, the main culprits for the increase were shelter, gasoline, and food all of which surged in May year-over-year.
To combat high inflation, the US Federal Reserve continues to pursue a monetary policy that will likely see continued interest rate increases. In June, the Fed raised its benchmark interest rate by three-quarters of a percentage point, the most aggressive rate increase since 1994. The US 10-year Treasury Yield hit 3.48% on June 13, 2022 before pulling back to 2.89% at the end of the second quarter. Given the rising interest rate environment—with tightening monetary policy impacting the short end of the curve and high inflation pressuring the longer end of the curve—bonds continued to sell off in the second quarter.
With the higher cost of living, real wages are being eroded as incomes are not keeping pace. Real average hourly earnings decreased 0.6% from April to May 2022 and decreased by 3.0% on a year-over-year basis. As a result, consumers are dipping into savings to drive overall spending. A clear concern is whether consumers will continue to draw down savings in the face of confidence-rattling challenges and increasing interest rates. Additionally, corporations are taking precautionary measures to reduce labour costs, given the uncertain economic backdrop. The combination of high inflation, tightening monetary policy, and reduced consumer and corporate confidence dramatically increases the potential for a recession. Another potential outcome of current conditions, in isolation or in tandem with a recession, is a period of stagflation. Stagflation occurs during times of high inflation and high unemployment. Typically, high inflation is caused by an external shock to supply (e.g., higher oil prices due to reduced oil and gas production), while high unemployment is a result of declining demand, usually owing to lower consumer confidence and falling purchasing power. Even though the ingredients for a period of stagflation are present, employment still stands at record levels and is nowhere near the double-digit unemployment in the 70s and 80s, leading some commentators to discount the current possibility of a stagflation experience.
At Evolve Wealth Advisors, we remain mindful of the potential for a recession and/or stagflation. However, we do not attempt to time the market, and, given our long-term approach to investing, we are ready to capitalize on near-term market dislocations that present attractive investment opportunities on both a relative and an absolute basis. Over the long term, we remain confident that the US and other developed market economies will drive economic growth. With this favorable long-term outlook in mind, we remain positive on equities, particularly given the meaningful pullback in valuations over the first half of 2022 and the ability of certain companies to compound their earnings over the long term.
Additionally, we are incrementally more positive about fixed income because of the new environment of rising interest rates. That said, we believe that price risk remains elevated as there is an increased probability of a higher interest rate environment, as well as wider credit spreads should the economy enter a recession.
From an asset mix perspective, we prefer equities and alternative investments over bonds. Consequently, we have kept our asset allocations largely consistent quarter over quarter.
To learn more about Evolve Wealth Advisors, please visit our website at www.evolvewealthadvisors.com. Should you have any questions regarding your account or how Evolve Wealth Advisors can help with your future Estate or Retirement planning needs, please contact Peter Henry, CEO at 818-970-6940 or Patrick Kinney, COO at 503-490-0273
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