The Quarter In Review | 1Q 2022
TOPLINE TAKEAWAYS FOR FIRST QUARTER, 2022
The U.S. economy decelerated in the first quarter with GDP Quarter / Quarter growth declining -1.4 percent. The Russian invasion into Ukraine exacerbated the backdrop as markets grappled with the global implications of a war. Inflation, tightening financial conditions, and ebbing consumer confidence added to uncertainty in the markets.
FIRST QUARTER RETURNS
Global equity markets experienced volatility as global monetary policies began to tighten. Equity markets dropped sharply during the quarter, with U.S. markets down -5.28 percent. International Developed Countries and Emerging Markets also fell, down -4.81 percent, and -6.97 percent respectively.
During the quarter, U.S. large cap value stocks held relatively steady, down -0.74 percent, while large cap growth stocks led by the technology sector were off -9.04 percent.
A globally diversified portfolio of 50/50 equities and fixed income declined -5.60 percent for the quarter.
FIXED INCOME
Interest rates increased across all maturities in the U.S. Treasury market for the quarter as the Federal Reserve embarked on its rate hike campaign, which is expected to deliver multiple rate increases in 2022 and 2023. Increasing rates strengthened the U.S. dollar relative to other currencies.
Interest rates and bond prices have an inverse relationship: when interest rates go up, bond prices decline and vice versa. The longer term the maturity of the bond, the greater the impact of rate changes on that security. As interest rates went up, respectively the Bloomberg U.S. Aggregate Bond Index slumped -5.93 percent for the quarter. Shorter maturity bonds (one-year notes) were only slightly down -0.80 percent, whereas 10-year bonds significantly declined -10.5 percent for the period.
ALTERNATIVE INVESTMENTS
The advance in commodity prices was resuscitated by the crisis in Europe, which saw energy, grain, metals, and natural gas prices surge, somewhat offset by the strengthening U.S. dollar. The Bloomberg Commodity Index surged in the first quarter by +25.5 percent led by oil and natural gas prices, both of which were up over +55 percent for the quarter.
After leading all asset classes in 2021, Real Estate Investment Trusts (REITs) cooled off for the period, down -3.71 percent for the quarter.
A DEEPER DIVE ON INFLATION AND THE FED
Inflation has been one of the most widely reported and discussed economic factors in the past 18 months. Surging energy, rents, building materials, automotive, food and supply disruptions have boosted the year-over-year rise in the inflation rate to the fastest pace in decades.
The inflation rate jumped from 2.3% in the 12 months ending in December 2019 to 8.5% in the 12 months ending March 2022, the fastest such increase in 40 years.
Most Americans have suffered a substantial fall in their standard of living over the past 12 months. In the latest available 12-month change, 116.2 million American-wage and salary workers suffered a 3.7% decline in their inflation-adjusted paychecks, the largest drop since 1980. This alone more than offsets the gain in income going to the 6.5 million newly employed in the latest 12 months.
As inflation began to surge in late 2020 and throughout 2021, where was the Federal Reserve?
I put them in the “Often Wrong but Never in Doubt” camp, as some of their comments last year appear out of touch with what was actually happening:
April 5, 2021 - “I am unconcerned with inflation running away from us.”
May 5, 2021 - “I’m not worried about inflation getting out of control.”
May 14, 2021 - “I’d like to see inflation rise to 2% or higher.”
Aug 27, 2021 - “By the end of the year, I expect inflation to be between 3.5% and 4%, with a drop in 2022.”
Sept 24, 2021 - “Inflation will be little more than 2% next year.”
After more than a year of taking the position that this inflation surge was transitory, at the May meeting, the Federal Open Market Committee (FOMC) finally embraced reality and raised the fed funds rate by 50 basis points, to a range of 0.75% to 1.0%. It was the largest rate increase since 2000.
We are already 24 months into this inflationary period. To put this into context, looking at the last eight inflationary shock periods dating back to 1949, none were longer than 28 months and in all but one instance led to a recession.
Data Source: Federal Reserve
Interesting enough, of the 12 regional presidents of the Federal Reserve (all of whom are appointed), only one has ever worked anywhere else outside the Federal Reserve (Barkin).
Loretta Mester, Cleveland John Williams, New York Jim Bullard, St. Louis
Esther George, Kansas City Mary Daly, San Francisco Charles Evans, Chicago
Raphael Bostic, Atlanta Kenneth Montgomery, Boston Meredith Black, Dallas
Patrick Harker, Philadelphia Thomas Barkin, Richmond Neel Kashkari, Minneapolis
Lastly, prices in core industrial metals have started to top out and decline over the past few months:
Iron Ore down another -4.4 percent this week and -11.1 percent in the last month
Aluminum down another -2.0 percent this week and -13.2 percent in the last month
Zinc down another -3.2 percent this week and -9.0 percent in the last month
Copper down -4.2 percent this week and -6.9 percent in the last month
Aluminum down -6.0 percent this week and -11.6 percent in the last month
Given all that has transpired, this is not the time to be continually raising interest rates, and the markets are telling us they do not believe the Fed will be able to navigate any type of smooth landing.
The challenge in all of this is that the Federal Reserve is constantly trying to apply academic linear theories to the U.S. Economy that is anything but linear. The two are incongruent, thus consistently leading to less-than-ideal outcomes.
ECONOMY AND THE MARKETS
A lot has changed over the last 24 months as it relates to the economy and the markets.
The University of Michigan indicates consumer sentiment in the first quarter was worse than during the height of the 2020 pandemic and at the levels of the beginning of the very deep 2008-09 recession. Consumers cut back significantly on their buying plans as expectations for increases in future income slumped. To fund the sharply higher cost of necessities, households have been forced to reduce their personal saving rates.
In addition, there are metrics that tell us the economy and corporate earnings are slowing:
First Quarter GDP (Year over Year) came in at -1.4 percent, vs. expectations for +1.0 percent growth
The National Federation of Independent Businesses (NFIB) had the lowest Forward Outlook in 30 years
Pending home sales have dropped by 20 percent since October
We have said before -- risk happens slowly, and then all at once.
The “all at once” part just happened.
At the time of this writing, both stock and bond markets have sold off massively. Here are yield-to-date results for a few key indices and widely held stocks:
Vanguard Total Stock Market Index (VTI) down 18.9 percent
Total Bond Market Index (BND) down 9.7 percent
Slowing growth expectations have crushed high-performing and so-called FANG stocks + Tesla
Apple (AAPL) down 19.0 percent
Netflix (NFLX) down 70.5 percent
Tesla (TSLA) down 37.5 percent
Amazon (AMZN) down 37.7 percent
Facebook (FB) down 43.6 percent
We have said for some time that just because a company is large and dominant and might stay at the top of the “largest companies” in the world chart for years, it doesn’t necessarily mean it is also a great investment going forward. Rather than chasing performance of today’s top companies, we want to be sure we are well positioned to capture the returns of tomorrow’s top companies. We can do that by holding broadly diversified portfolios that hold a wide array of companies and sectors.
The above declines are a good reminder to not have all your eggs in one style (growth), sector (technology) or country. Contrasting to the results above, Vanguard Value (VTV) comprised of stable companies such as J&J, JPMorgan, Berkshire Hathaway and United Health Group is only down -5.8 percent on a year-to-date basis.
LOOKING FORWARD
We expect inflation to continue to be high. However, we believe we are entering a period of disinflation, which is a period of slowing the rate of inflation. That should not be confused with deflation, which is reduction of the general level of prices in an economy.
With the stock market selling off and inflation at a four-decade high, it is human nature to want to take action to protect your shrinking account balances. People tend to act rashly in times of financial stress, and often in their own worst interest.
This is clearly a time of uncertainty; however, it can be hard to do nothing when markets are rough. Given what has been happening recently, we always come back to our investing principles:
HAVE AN INVESTMENT PLAN
An investment philosophy serves as a compass to guide you through turbulent times. When you have a compass, it doesn’t take drastic directional changes to find your way. Establishing and adhering to a well thought out investment plan, ideally agreed upon in advance of periods of volatility, you can remain confident and calm during periods of short-term uncertainty.
ALIGN PORTFOLIO RISK WITH GOALS
As investors, our risk appetite often changes based on the market environment we are in. You want to have a plan in place that gives you peace of mind regardless of the market conditions.
STAY DISCIPLINED / BE PATIENT
Financial downturns are unpleasant for all market participants. While no one has a crystal ball, adopting a long-term perspective can help change how you view market volatility.
Remember, we’re here to help. This also is where the time invested upfront with each of you shows its value. Formulating a solid and adaptable financial plan together and discussing liquidity, cash flows, and reserves, provides the solid footing needed for times like these with many changing facets.
We appreciate the opportunity to work with each of you. We recognize that each client’s situation is unique and incorporates different factors into their investment and financial plan.
As always, if you have any questions or concerns about current market trends and the impact on your personal situation and plan, please contact us and we would be happy to discuss.
Please follow this link to read the complete Quarterly Market Review | 1Q 2022.