It would be an understatement to say that financial markets struggled in the first half of 2022, as global stock and bond benchmarks fell a respective 22% and 9% during the six-month period. Our geopolitical, economic, and pandemic concerns at the beginning of the year became realities with the passage of time, as we witnessed new COVID-19 lockdowns in China, a raging war in Ukraine, and surging inflation around the world. In response to these developments, Fed Chair Jay Powell and his fellow Central Bankers have responded with tight monetary policies by way of higher interest rates, in their concerted effort to reign in rampant inflation and high energy prices.
With inflation readings registering at a 40-year record high, and with expectations for future inflation the highest in a decade (per the University of Michigan inflation survey), the odds of an economic recession in the United States have been increasing. But there are still bright spots in the economy, including a strong job market (featuring 390,000 new jobs added in May) and a record low unemployment rate of 3.6%. In addition, wages have been on the rise, with a recent report showing a 5.2% year-over-year increase in earnings for workers. The U.S. consumer, which accounts for approximately two thirds of the overall economy, also appears to be in decent financial shape, with household debt at its lowest in 20 years to go along with $2 trillion of excess savings accumulated by the consumer during the pandemic.
Fed Chair Powell has been clear in stating how serious the Federal Reserve Board is in bringing inflation under control – emphasizing that their policy would be “expeditiously” administered. In turn, the market has been pricing in a significant hike in the Federal Funds rate to above 3.5% in 2023. Consequently, with the Fed’s efforts to cool the economy gaining momentum, the U.S. housing market is beginning to show the negative effects of higher interest rates. Recently, April existing home sales fell by 2.4%, making it the third consecutive month of declines. In addition, new home sales dropped 16% this Spring as buyers were forced to adjust their budgets due to higher borrowing costs (i.e., the 30-year mortgage rate recently eclipsed 6%).
From an investment standpoint, bear markets (the most recent commencing in mid-June) have frequently been a precursor to strong future returns for stocks. For example, when looking back over the past fifty years, dour readings in consumer sentiment have tended to coincide with positive returns of over 20% for U.S. equities in the following year. Keeping this in mind, it is more important than ever to manage one’s emotions and to not lose sight of the long-term investment horizon. In our approach, we will continue to rely on diversification in our investment process, with a particular emphasis on owning high quality stocks and bonds. With the second quarter recently concluded, we will soon hear from CEOs of a broad range of businesses regarding their corporate results and outlook for the year. We anticipate some negative commentary and job layoff announcements from companies and will be paying close attention to their corporate guidance for the remainder of the year as well as other remarks regarding business conditions.