1st Quarter 2022 Review
In our 2021 year-end review, we wrote about how 2022 did not appear to have as favorable of a backdrop when compared to 2021. We felt this to be the case due to the expected rise of interest rates from the Federal Reserve. This tighter monetary policy can keep stocks from advancing as quickly as they have the past few years and, in fact, this rise in interest rates caused both stocks and bonds to retreat during the first quarter of 2022. While stocks historically can still perform well during a rising rate environment, inflation appears to be a strong risk for the market. If inflation continues to run hot, the Fed's hand will be forced and they will need to raise rates quicker than they would like. This tighter monetary policy could cause the economy to weaken and even could trigger a recession. While most economists feel this is unlikely, Goldman Sachs raised their recession odds to a 20-35% chance of occurring in 2023. Based on this research it seems certainly possible that this bull market could be considerably shorter than the prior bull market which ran roughly 11 years before the global pandemic caused a 34% drop in the S&P 500 in 2020. While the Fed tries to fight off inflation, Ukraine continues to try to fight off Russia. This geopolitical risk also had a negative effect on stocks for the first quarter. While headwinds exist in 2022, some of these risks could subside if the war resolves and inflation numbers start to decline towards year end.
Domestics stocks declined 5.2% for the first quarter of 2022 as measured by the S&P 500 Index. While this decline is unpleasant, the market did rebound a fair amount off its March 8th trough where the S&P 500 was off nearly 13%. Typically a market correction is defined as a 10% decline in the stock market. It shouldn't be too surprising that a pullback of 13% occurred given three (3) straight years with stocks advancing 18% or more annually. Tech heavy NASDAQ stocks have particularly struggled as of late being down 11.2% from their all-time-high on November 19, 2021. Mid-cap company stocks fell by around the same amount as the S&P 500 this past quarter; however, small cap stock performance lagged, posting a loss of 7.5%, as measured by the Russell 2000 Index.
International and Emerging Markets
In the beginning of the year, developed international stocks were tracking ahead of U.S. stocks for performance; however, with war breaking out in Europe, these stocks ended up roughly 6% lower for the quarter. German stocks at one point entered bear market territory with the DAX Index being down over 20%. Per The Wall Street Journal, Germany receives around half of their gas from Russia, putting the country in a precarious position.
Emerging market stocks fell roughly 7% for the quarter. While developed international stocks struggled due to the Ukraine/Russia war, some emerging market countries are still struggling with the ongoing pandemic. COVID-19 cases rose in Shanghai recently and millions of citizens were once again locked down. Given the vast amount of manufacturing that comes from China, the supply chain disruptions should be expected to continue, which could put further upward pressure on prices. Perhaps inflation won't be able to be kept in check until the global pandemic finally eases or ends.
Our firm continues to underweight client exposure to both developed and emerging market stocks. The S&P 500 Index has returned more than double the EAFE and MSCI Emerging Markets Index over the past 3 years. While these stocks have been a detractor to performance, academic research has consistently concluded that adding at least some international investment leads to a more diversified and less risky portfolio. We maintain the position that having some of these stocks do hold merit, but we feel an underweighting of these stocks continues to make the most sense.
While investors expect volatility and occasional declines in their stock portfolios, the volatility seen across safer fixed income investments made investing challenging for the first quarter. The Aggregate Bond Index ended down 6.2% for the quarter, a full percentage point more than if you had just invested in stocks. This was attributed to the aforementioned rise in interest rates. While this rise in rates makes sense given inflation, the velocity at which rates increased is somewhat shocking. The bond market, like the stock market, tries to predict the future and is trying to anticipate where the Fed could raise interest rates to. Given where current rates stand, the bond market is predicting around nine (9) further .25% rate hikes in 2022…but, predicting the Fed’s moves over the rest of the year is very difficult. If the Fed raises rates slower or less than expected, bonds could actually rally and interest rates could even decline. It’s also important to understand that with rates going up, it means fixed income investments will pay a higher rate going forward to investors. So, in this way, it could mean that this short-term pain will lead to longer term gains for bond investors.
One other event that recently occurred is the inversion of the yield curve where, at least momentarily, the yield on a 2-year treasury bond was higher than the yield on a 10-year treasury bond. Typically this wouldn’t make sense for investment, as usually you’d want to get paid more interest for tying your money up for ten (10) years versus only two (2). This inverted yield curve has also been known as a predictor of a future recession. While recessions have always, at some point, followed this inversion, this predictor isn’t foolproof and it’s worth noting that when the yield curve inverted in 1988, the S&P 500 Index rose over 37% before a recession started.
A major theme for the first quarter was the meteoric rise in commodity prices. While oil and gas prices get the most press, commodities as a whole have surged over 25% percent in the first quarter. This is the highest gain for commodities in a quarter since 1990. While prices were already trending higher, the war between Russia and Ukraine made many of the components within this index skyrocket. We are also seeing a strengthening of precious metals, such as gold, increase in value with this heightened geopolitical risk. Some of these prices, however, have already started to decline and it’s possible that we are at or near peak inflation.
What's Ahead for the Rest of 2022
While the market experienced a correction in the first quarter, stocks rallied back roughly 8% from the bottom to close out March. The question now is whether this is more of a bear market rally or was the prior low point already established? Will we retest the low point we saw on March 8th? There's no shortage of risks for the market but things can also prove to be better than what the market is perhaps expecting. The shocking rise in commodity prices will likely extend this inflationary period that the Fed previously projected as being "transitory". It’s possible we are currently at peak inflation as that’s the base case for trillion dollar asset manager PIMCO whom our investment team met with recently. If a somewhat peaceful resolution develops between Ukraine and Russia, and the global pandemic reaches its end phase, inflation could decline. So while there are risks that increase the odds of a recession, alternatively, the economy could get back on track and pent-up demand for things like travel and leisure could still spread across the economy. A low unemployment rate and a U.S. consumer being well positioned to spend could allow the economy to continue to grow for years to come. Additionally, consumer sentiment is very low, which has historically been a great time to buy stocks.
2022 is off to a tricky start for investors, but having a diversified portfolio can help you to manage risk. While this quarter was largely negative for investments, it is important to maintain discipline and remember that your goal is to win in the long-term. At CRA, we strive to be your coach and advocate to help you and your family achieve your financial goals for years to come.
CRA Investment Committee
Matt Reynolds CPA, CFP®
Tom Reynolds, CPA
Robert T. Martin, CFA, CFP®
Gordon Shearer Jr., CFP®
Jeff Hilliard, CFP®, CRPC®
Joe McCaffrey, CFP®
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