April 2022 Market Update: No Safe Space
Investing Market UpdateApril 2022 Market Update: No Safe Space
This quarter was a challenging time for investors with some expected and unexpected events contributing to investment losses in almost every invest-able area.
Bad News Review:
- In the stock market, nine out of eleven sectors suffered losses this quarter with only energy and utilities seeing gains.
- Bonds had their worst quarter in 20 years. US bonds fell 5.9% in the beginning of 2022 as the Federal Reserve began interest rake hikes on the path to tame inflation.
- Developed and emerging international markets are also down for the year (5.8% and 6.9% respectively).
- With inflation surging, cash is not a profitable place to hold funds.
- Commodities, the perennial loser of the past number of years, became the biggest winner of the start of 2022 as the war and inflation led to a surge in prices.
2022’s Major Headwinds:
- Russian invasion of Ukraine
- High inflation
- Interest rate hikes
- Continued supply bottlenecks
Index Performance Year-To-Date
(as of March 31, 2022)
- S&P 500 Total Return (Top 500 U.S. Companies): -4.60%
- NASDAQ Composite Index (Top 100 U.S. Companies): -8.95%
- Bloomberg US Aggregate Bond (U.S. Bonds): -5.93%
- MSCI ACWI Ex-USA Total Return (Non-US Companies): -5.44%
Stocks had a rocky start to the year – likely due to already high prices combined with an unexpected Russian invasion of Ukraine. The S&P 500 entered correction territory in February – down over 10% from the recent peak. In March, stocks partially rebounded, ending the quarter down 4.6% year-to-date (as measured by the S&P 500). Elevated valuations and interest rate increases will continue to be tough on growth-oriented stocks in the near term.
Inflation and the Fed
Core inflation (which excludes volatile food and energy prices) is up 6.4% year over year (as of March 2022). This is the highest reading since 1982. Pressure has been building for the Federal Reserve to start raising rates.
And after much anticipation, the Federal Reserve took action and raised interest rates by 0.25%. With that raise and a signal to multiple future raises, the Fed now working to tame the inflation beast.
But market participants are signaling to the Federal Reserve that more action needs to be taken – eight rate hikes this year are currently projected. At the start of the year, the market assumed the Fed would hike rates only three times this year.
The Fed will be challenged to increase rates while still focusing on its stated goals of maximum employment and price stability. A too slow Fed will risk further inflation, while a too quick Fed could tip the economy into a recession.
During Fed tightening, the market typically will anticipate and re-price before the interest rate increases begin. There can always be an element of uncertainty – about the timing, size of hikes, or the number of rate hikes. Any deviation from market expectations will likely cause volatility in the return of bonds.
The US yield curve briefly inverted in March. This occurs when 2-year bond yields are higher than 10-year bond yields. Historically, this move has signaled that a recession may be somewhere on the horizon (though it has typically occurred a few years out).
The Implications of War
The war in Ukraine is likely to continue to promote renewed fragmentation of the world. A cease-fire would not allow the world to quickly bounce back to a version of ‘normal’. Countries will continue to pursue a more self-sufficient stance.
Most European countries are currently turning to conventional energy sources to fill the gap left by decreasing reliance on Russia. However, in the longer term, these countries will likely push towards more renewable options to reduce reliance on resources from countries deemed hostile.
Looking Forward
Increasing interest rates will continue to weigh on long-term and investment-grade bonds. High-yield bonds could achieve a higher return but will generally also increase investment risk. We prefer to defer to active management in the bond sector to determine what to hold in the near term.
Inflation will continue to stay high but should moderate somewhat. Inflationary pressures in some sectors – like food, energy, and vehicles should abate in the coming months. Other sectors, such as shelter costs, will remain higher. Certain stocks (like value) and commodities can provide some protection from inflation. While commodities may look good now, remember they are typically subject to high levels of price volatility and long periods of weak investment returns.
What’s an Investor to Do?
In the bond universe, when rates are rising rates, investors typically reduce duration (favor more short-term bonds). This move will lower current income from bonds. Alternatively, investors can consider higher-yield bonds which tend to act more like stocks. Investment risk is typically higher than with investment-grade bonds.
Rising rates also affect stocks. Increasing rates are typically worse for tech and more growth-oriented companies. Investors paying a high price today for future growth will find those growth expectations diminished. Stock factors that are attractive in a rising interest rate environment include value, quality, and dividend-focused companies.
Internationals shouldn’t be overlooked. Positive growth could be found in Latin American countries this year as they are heavily driven by commodities. Balancing US and international investments can pay off in the long run as the economic cycles around the world move on different paths.
The future economic outlook is complicated. We are likely moving into a late-stage growth cycle with weaker economic growth forecasted than assumed before the war. This doesn’t spell immediate and harsh doom and gloom – but the above-average returns we have seen over the past few years may no longer be the norm.
At the end of the day, it’s important to ensure your portfolio is built to meet your needs. It’s difficult, if not impossible, to precisely time market shifts. A proper portfolio is ready to roll with the ever-changing market tides.
Price volatility shouldn’t be feared but is a function of a healthy economic market. As cycles shift, portfolio re-balancing will be important. Re-balancing ensures that various exposures remain proportional.
While recession risk is increasing, it does not mean we should hide everything under a rock. Stay diversified. Ensure your near-term needs can be met with funds on hand and lower volatility investments. Have a plan to ride out future storms - or work with an experienced financial advisor.