Spring 2022 Market Commentary
By Marc Usem and the Affiance Financial Investment Committee.
U.S. equity markets reached their all-time highs during the first few days of January before sliding by more than 12% through mid-March. The “correction,” defined as a 10% drop in a market index, took many investors by surprise. The market had spent the prior 21 months recovering from the Covid-19 pandemic with barely a 5% dip. In fact, prior to the pandemic shutdown the most recent 10% correction was in December of 2018. Many investors, who had become accustomed to a low-volatility environment, have become nervous due to the recent market action which we expect to remain more volatile in 2022.
A confluence of events triggered the first quarter market correction including: spiking inflation reaching a 40-year high of nearly 8%, rising interest rates with 10-year treasury yields jumping by 0.5%, Russia waging war with Ukraine, and stock market leaders Meta (Facebook) and Netflix losing half of their value after missing earnings expectations. Clearly, the world has changed. The illusion of relative safety in FANG stocks has been shattered. Rotation from growth to value stocks followed suit in early 2022 with investors preference for safety in lower risk stocks making a showing once again, similar to the temporary surge we saw in early 2021.
International markets have long lagged domestic shares, but had a glimmer of glory in early 2022. However, their relative outperformance through February dissipated quickly in March with downside performance in-line or worse than the S&P 500. Globalization has been called into question given the Covid-19 shut downs in China, war in Ukraine, and continued supply chain disruptions. Moving operations on-shore seems reasonable to secure a more stable supply. The result may reverse decades of deflationary forces due to low-cost off-shore production. Domestic productivity will need to increase through more efficient applications of technology across industries to curb longer-term inflationary pressure. This is likely to bring a new period of risks and opportunities in the coming decade.
The Fed’s statements were clear during early 2022, that it planned to raise rates by 0.25% in March, and it did exactly what was promised. Bond yields rose in anticipation of the event and then spiked higher on the news. Bonds have not been a place to hide in 2022, as higher interest rates have driven bond prices lower. The Bloomberg Barclays Aggregate Bond Index was down 6% during the first quarter. Even “safe” short-term bond funds have slipped lower due to rising rates. The combination of lower stock and lower bond prices have left investors with few places to hide. The adage that “cash is trash” (due to inflation) was not the case relative to losses in both the stock and bond markets during the quarter.
Recently, the yield curve inverted with 2-year treasury yields higher than 10-year yields. Historically, this has been a sign that a recession may be likely in the next 12 to 24 months. We are not forecasting an imminent recession, but simply point to another sign that more volatility is likely during the coming year. We would note that stocks have done well during periods from initial yield curve inversion prior to a recession, but additional caution is warranted.
To reach the next leg higher in markets, we expect we will need to wade through a period of higher market volatility. Pandemic spending and monetary stimulus will fade by design. Consumer spending will ebb back to baseline demand for 2 to 3% economic growth. The Fed will move rates higher to combat inflation by slowing the economy against the backdrop of a tight labor market. This is all normal and needed to reset monetary policy for the next downturn while moving the economy to stand on its own footing rather than on government support.
Markets will find equilibrium in time and we will continue to remain focused on those things we can anticipate and control - maintaining asset allocation in-line with risk tolerance and risk capacity, keeping cash as needed for planned withdrawals, and remaining diversified and disciplined. Staying with your financial plan will lead to the best financial results.
Thank you for your continued confidence in our work.
The views represented in this commentary are not meant to be construed as advice, testimonial or condemnation of any specific sector or holding. Investors cannot invest directly in an index. Unmanaged indexes do not reflect management fees and transaction costs that are associated with some investments. Past performance is no guarantee of future results. To discuss any matters in more detail, please contact your financial advisor.