Market Update April 13, 2022
While there have been much worse quarters for the financial markets (think back to March 2020 and the coronavirus sell-off), the first quarter of 2022 was a bit of an eye opener for investors after a fairly steady climb the past two years. Russia’s invasion of Ukraine and the responding sanctions by the Western world sent energy prices skyrocketing, exacerbating what was already a period of very high inflation. Compounding matters is the Federal Reserve which is very late to the table in tightening monetary policy to combat inflation. The Fed is now expected to raise the Federal Funds rate by 50 basis points (.50%) at the conclusion their meeting on May 4th, up from their more recent history of 25 basis point adjustments. Similar increases are expected over the course of the year.
The result was a difficult 1st quarter for both stocks and bonds. U.S. stocks held up slightly better than their foreign counterparts, largely due to a strengthening of the U.S. Dollar, as commonly occurs at the onset of geopolitical tension. Large company domestic stocks as measured by the S&P 500 were down 4.6%, the MSCI EAFE index of established foreign economy stocks was down 5.9%, and the MSCI Emerging Markets index was down 7.0%. Here in the U.S., large cap value stocks held up very well compared to growth stocks, down just 0.2% in the first quarter as measured by the S&P 500 Value index.
Bond interest rates have risen in anticipation of the Fed aggressively raising the Federal Funds rate, causing bond prices to fall due to the inverse nature of bond yields and prices. Investors hoping to dampen risk in portfolios by holding bonds were likely disappointed with portfolio performance in the 1st quarter, as bonds measured by the Bloomberg U.S. Aggregate index were down 5.9%, every bit as bad as stock returns. I have been a proponent for some time of using alternative income-producing asset classes in lieu of bonds for a portion of the income segment of balanced portfolios, and this past quarter was a prime example of the merits this strategy can have.
With the recent weakness in bonds and concurrent rise in yields, bonds are becoming more attractive. As a point of reference, at the end of 2021 the yield on the 10-year Treasury bond was 1.51%. On April 11, the yield closed at 2.78%. This yield is close to a level that could result in at least a pause in the rise in yields, and provide some relief, if not a rally, in bond prices. I believe the anticipated Fed rate hikes are largely reflected in bond prices and yields. It was noteworthy that bonds rallied yesterday (April 12) despite another out of the ballpark inflation report. The belief is that inflation has likely peaked which is a fair assumption. One year from now, when inflation gets calculated year over year, it is hard to imagine a scenario in which prices would have shot up as much as the previous 12 months. While inflation and Fed rate hikes may now be pretty well factored into bond prices, the impact of the Fed unwinding their huge balance sheet is difficult to predict. With the Fed no longer buying Treasury Bonds and mortgage-backed securities, the question is if there will be enough demand from other buyers to hold up prices. If not, a further rise in yields would result.
While the Fed is way behind the curve in cutting back monetary stimulus, other countries are not. A prime example is Brazil, who’s central bank began increasing rates in March of last year. The advantage countries such as these will have is when global economic growth slows again, they will have monetary ammunition stockpiled to again stimulate their economies as needed. Thankfully for globally diversified investors, not every central bank is in the same quandary as our own.
In follow-up of my “Troubling Times” blog on March 16, and reference to the yield curve as being a reliable predictor of recessions, there was much fanfare two weeks ago when one of the widely watched yield curves briefly inverted (the 10-year versus 2-year Treasury curve). I have found the 10-year versus 3-month Treasury curve to be a more reliable indicator. This yield curve is nowhere near flattening and has even been rising which is a positive sign for the economy and financial markets. Valuations are very attractive in many segments of the stock market and investor sentiment is terrible, which is positive for the outlook. All of these lead me to believe there is hope on the horizon.
Sincerely,
Glenn S. Rank, CIMA®
Certified Investment Management Analyst®
President
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