Quarterly Newsletter for the 2nd Quarter 2022
We began this year with the expectation that the U.S. and the global economies would continue to recover from the effects of the COVID pandemic. While that holds true, the pace of change in macroeconomic fundamentals, such as inflation and recession fears, have failed to live up to expectations. These specifics have overshadowed the positives and led the markets to significant declines. On a price return basis, the Dow Jones Industrial Average (DJIA) was down 15.31% year-to-date through June 30. The Standard and Poor’s 500 (S&P 500) was down 20.58%, while the NASDAQ was down 29.51%. Overseas, the MSCI all Country World ex-US Index dropped 19.72% year to date. In the fixed income environment, the Barclays Merrill Lynch 3-month Treasury Bill Index yielded 0.14% year to date.
Fixed Income Market (Bonds): The Federal Reserve has been leading the fixed income market. As stated in our April newsletter, inflation, which at one point was viewed as being transitory and is now considered a persistent threat, is at a 40-year high. In an effort to control inflation, the Fed has been raising interest rates. During its July meeting, the Fed raised the rate 0.75%. Additional increases are expected in each of its three remaining meetings this year (September, November and December). Additionally, the Fed has begun its quantitative tightening as a means of shrinking its massive balance sheet. Talks of an “inverted yield curve” (when short-term interest rates are higher than long-term interest rates) are also prevalent. All of these facts are of concern to us. As we have stated so many times: when interest rates increase, the underlying value of a bond decreases.
US Equity Market (Stocks): The Russian/Ukrainian war, inflation, and the threat of recession all helped the second quarter acceleration of the market correction that began in the first quarter. All three major US indexes breached the -20% bear market threshold in the middle of June. Recession is a concern, but we do not view it as a major problem today. The Russian/Ukrainian war has certainly upset energy supplies- particularly in Europe. It has also upset specific agricultural markets in the midst of an already fragile global supply chain. In our opinion, inflation is the biggest problem facing our US economy today. The bellwether inflation index, the Consumer Price Index (CPI), has jumped to a forty-year high. This has caused widespread concerns as households face drastically increasing prices in almost all categories, not the least of which are food and gasoline costs. Consumer spending accounts for about 70% of the US economy. As the costs of household staples rise, the spending on discretionary items decrease. Despite these headwinds, the US economy is still in good shape. Corporate balance sheets are strong, unemployment is low, corporate profits are steady and employee wages continue to increase. These are all factors you would not see during a recession.
Overseas Equity Market (Stocks): The war between Russia and Ukraine and the problems in China continue to be the focal point of conversation and the two most predominant economic issues overseas. The war is lingering much longer than anyone predicted and is severely affecting certain geographic areas such as eastern Europe. China has several major issues. Their zero COVID policy has led to lock downs which, in turn, have impaired their manufacturing and exporting business. Additionally, they are facing a tech recession and looming questions regarding the full and fair disclosures of their corporate reporting.
Conclusion: Selling stocks in a crisis is very likely to result in missing the recovery. While recent events are testing investor’s resolve, history indicates that the best strategy for building wealth is to stay the course and invest for the long run- even if it feels difficult to do so. We are positive on US equities markets and see positive returns by the end of the year. With rising interest rates, we remain negative on the long-term fixed income market and favor short-term bonds. On the overseas market, we remain neutral and probably will be until the Russian/Ukraine issue is resolved.
In closing, permit us to express our sincere appreciation for the opportunity to be of service to you. As always, should you have any questions or wish to discuss the above in more detail, please do not hesitate to contact us