Global Market Review and Outlook

Source: Bloomberg

After a largely one-directional market experience in 2021, our expectation was for more volatility coming into 2022. We were given that and then some in the first quarter. To start the year, the S&P 500 pulled back 13% from highs, and the technology- and consumer-discretionary-heavy Nasdaq dropped 21% from its peak. For perspective, both indices have doubled from their March 2020 COVID-induced lows. Momentum changed for the better in March and the indices regained ground. The S&P finished the first quarter down 5% and the Nasdaq ended down 9%. The only sectors in positive territory in the first quarter of 2022 were energy (+39%) and utilities (+5%).

More noteworthy than stocks, bonds experienced their worst quarter in over four decades. At the end of last year, the Federal Reserve made clear that the market needed some medicine—interest rate increases and quantitative tightening—to combat persistent inflation. The first interest rate hike of 0.25% was enacted in March. Two percentage points in additional increases are expected throughout the year, and with inflation running hot at close to 8% in the latest reading, we expect Fed efforts to be front-end loaded. This will include quantitative tightening (the unwinding of bonds on the Fed’s balance sheet), which is set to begin as soon as next month. Treasury markets have responded to the Fed’s clear signaling with substantial proportional moves in rates. While rates are still low in historical terms, the 10-year Treasury rose from 1.5% to 2.3% in the first quarter; as of this writing, the 10-year has risen further to 2.8%. When interest rates rise, the prices of bonds fall. Consequently, the Bloomberg Barclays U.S. Agg Index, the broad U.S. government and corporate bond market index, declined 6% in the first quarter. In addition, the shape of the yield curve is closely watched. A steeper yield curve (investors are paid more interest to lend money for longer durations) is indicative of healthy economic growth. Conversely, an inverted yield curve (2-year has a higher interest rate than the 10-year) can signal a recession in the coming 6-24 months. The yield curve is currently flat and briefly inverted in early April, flashing a warning signal. The question of the timing of the next recession now looms as the Federal Reserve does its best to pump the breaks without stalling the economy. In the past, the average stock market returns 6, 12, and 24 months following a yield curve inversion have been positive.

Earlier in the year, central bankers were hopeful that as our economy reopened, supply-chain constraints would ease and inflation would moderate, enabling a slow and steady process of stimulus withdrawal to be achieved. The Fed has a stated dual mandate for low inflation and maximum employment. Unfortunately, the global pandemic and geopolitical strains have thrown a wrench in the plan. On a positive note, around most of the globe, the virus has become persistently pesky but much less dire, and economies are in reopening mode. In contrast, China, which was very strict from the beginning with its “zero tolerance” policy to COVID, is now belatedly experiencing mass spreading of the virus, leading to clampdowns in major regions of the country, shuttering manufacturing and ports. This is roiling a fragile global supply chain still very dependent on Chinese exports. We see an end in sight, but it will take more time.

Equally disruptive to the cost of goods (not to mention the tragic human cost) is the Russian invasion of Ukraine and war on the European continent. The United States has responded to the aggression with heavy sanctions on the Russian central bank, financial institutions, and imports, most notably energy. Allies have levied similar sanctions, putting some real teeth in the measures. While the conflict is on Europe’s doorstep and has a more direct impact on the continent, our European peers have been slow to move on energy sanctions. Russia supplies about 19% of the world’s natural gas and 11% of its oil. The EU gets 40% of its natural gas supplies and 27% of its crude oil from Russia. Obtaining new sources of energy will be a fruitful but multidecade exercise. Global tensions are high and rising, as both Russia and China flex their muscle. There is a clear shift away from globalization. In the meantime, higher prices at the pump and on the shelves will serve as a regressive tax on consumers, which will weigh on economic growth.

Fundamentals provide grounding, and current data is largely positive, especially in the United States. Corporate profits remain a bright spot, with S&P earnings growth anticipated to be in the high single digits this year. Balance sheets are healthy, and credit spreads are tight. Employment is strong at 3.6%. On the more cautious side, while price-to-earnings multiples for the S&P 500 have compressed to 19 times next-12-month earnings, they are still above long-term averages. In addition, 2023 U.S. GDP growth is expected to slow to 2%-3%. Against this backdrop, we continue to favor the United States and feel good about our weighting in high-quality growth stocks that are poised to grow faster than GDP. In a rising rate environment, volatility is expected but will also provide opportunities, and active portfolio management is paramount. As your trusted advisor, we are keeping a focus on the long term while being patient.