May 2022
US Economy: Negative GDP surprise.
The US economy unexpectedly shrank 1.4% in 1st quarter 2022 (first estimate), driven by a drawdown of business inventories and a record trade deficit. Meanwhile, strong personal consumption (+2.7%) and an easing in core inflation (+5.2%), the first year-over-year decline in 18 months, were bright spots.
US Stocks: Akin to March 2020.
Large cap stocks fell nearly 9% on concerns over rising interest rates, inflation and potential recession. While 80% of the S&P 500 companies already reporting earnings have beaten Q1 estimates, consumer bellwether Amazon had its first quarterly loss since 2015 and earnings growth has slowed broadly.
Foreign Stocks: Global headwinds.
Non-US equities slightly outperformed domestic stocks despite the drag of weaker currencies. Brazil and other major raw materials exporters that had benefited from the commodities boom were among the weaker performers on a stronger US dollar, rising US interest rates and their own historically high inflation.
Fixed Income: Rates march upward.
US interest rates continued to rise as the 10-year US Treasury reached 3%, a level not seen since the end of 2018, and bond market losses deepened. Futures market pricing suggests the Fed is likely to raise its key interest rate to more than 3% ultimately (vs. the current range of 0.75% to 1%) to aggressively combat inflation.
Real Assets: Energy business booms.
Commodities continued to outperform financial markets although the price of oil finished the month near where it began and gold slumped. While many commodities have soared, other real asset categories have generally lagged but have still provided beneficial diversification from equities.
Alternatives: Macro strategies lead.
One of the persistent themes of 2022 so far has been hedge fund investments cushioning some of the drawdown in stock and bond markets. Although hedge fund returns overall have not been robust, macro-oriented and managed futures strategies have performed exceptionally well by trading trends in both rates and commodities.
Equities Total Return
| APR | YTD | 1 YR | |
|---|---|---|---|
| U.S. Large Cap | (8.7%) | (12.9%) | 0.2% |
| U.S. Small Cap | (9.9%) | (16.7%) | (16.9%) |
| U.S. Growth | (12.1%) | (20.2%) | (6.8%) |
| U.S. Value | (5.8%) | (6.6%) | 0.8% |
| Int’l Developed | (6.5%) | (12.0%) | (8.1%) |
| Emerging Markets | (5.6%) | (12.1%) | (18.3%) |
Fixed Income Total Return
| APR | YTD | 1 YR | |
|---|---|---|---|
| Taxable | |||
| U.S. Agg. Bond | (3.8%) | (9.5%) | (8.5%) |
| TIPS | (2.0%) | (5.0%) | 0.7% |
| U.S. High Yield | (3.6%) | (8.0%) | (5.0%) |
| Int’l Developed | (7.6%) | (14.2%) | (18.2%) |
| Emerging Markets | (4.0%) | (6.7%) | (6.0%) |
| Tax-Exempt | |||
| Intermediate Munis | (1.8%) | (6.7%) | (6.5%) |
| Munis Broad Mkt | (3.0%) | (9.0%) | (7.8%) |
Non-Traditional Assets Total Return
| APR | YTD | 1 YR | |
|---|---|---|---|
| Commodities | 4.1% | 30.7% | 43.5% |
| REITs | (3.7%) | (8.7%) | 10.1% |
| Infrastructure | (3.3%) | 4.0% | 9.1% |
| Hedge Funds | |||
| Absolute Return | 0.8% | 1.0% | 1.0% |
| Overall HF Market | (0.7%) | (2.1%) | (1.4%) |
| Managed Futures | 5.8% | 19.4% | 20.0% |
Economic Indicators
| APR-22 | OCT-21 | APR-21 | |
|---|---|---|---|
| Equity Volatility | 33.4 | 16.3 | 18.6 |
| Implied Inflation | 2.9% | 2.6% | 2.4% |
| Gold Spot $/OZ | $1896.9 | $1783.0 | $1769.1 |
| Oil ($/BBL) | $109.3 | $84.0 | $67.3 |
| U.S. Dollar Index | 116.4 | 113.5 | 113.4 |
Our Take
After a remarkedly strong period for equities (2019-2021), the market regime change we said was possible in 2022 due to a variety of catalysts – Covid, supply chain disruption, inflation, interest rates, geopolitics – is now here. This new market and economic environment is marked by persistent and jarring volatility, much of it to the downside. Within equities, for example, the tech heavy Nasdaq index just had the worst start to the year since its 1971 inception, and you must go back to 1939 to find a worse start for the S&P 500.
The latest data suggest the US economy has certainly cooled from the robust pace of 2021, although we don’t think it is teetering on recession (officially defined as two quarters of negative growth). The factors that drove a drop in GDP growth in Q1 (20% surge in imports and lower inventory restocking) are not likely to be repeated in future quarters. And consumer spending (67% of US GDP) is supported by a pandemic “war chest” of $2 trillion in excess household savings, ongoing wage growth in nominal terms, and a record level of household wealth.
In the near term, the likelihood is for lower global growth as Europe bears the brunt of Russian energy sanctions and China’s zero-Covid policy pulls down its growth rate to below 5%. At the same time, monetary policy in the US and many key economies (except for China) is being tightened by central banks via interest rate increases and less bond buying to fight inflation that is now two to three times above the “sweet spot” of around 2%.
While we are starting to see some negative impact of wage and price inflation on corporate earnings, companies may be more resilient than they present. As is typical during times of economic turbulence, corporations appear to be using supply chain travails, geopolitical conflict, and China lockdowns to lower analyst expectations for future profit growth (and taking resulting hits to stock prices). From a contrarian perspective, this could be setting us up for positive earnings surprises in future quarters.
What We’re Doing
This down cycle, like virtually every one that preceded it, has started to shake the resolve of some investors given its four-month grind of volatility—some significant up days and many substantial down days. We’ve even had an extended period where bonds and equities have sold off in tandem.
While the opportunity set in front of us may have shifted somewhat, the volatility we are seeing today isn’t unfamiliar. In fact, market turbulence can present opportunities for patient, long-term investors, including: owning or incorporating new strategies to take advantage of market dislocations (including via hedge funds, private capital, real assets); tax-loss harvesting to bank loss carryforwards so we can then rebalance to manage risk in a tax-efficient way; and by being a liquidity provider to market segments in which other investors have trouble stomaching the volatility.
As interest rates rise, high-quality bonds will become increasingly attractive due to their higher yields, although prices could continue to suffer until rates peak. We are comfortable maintaining an allocation to fixed income that is shorter term (and therefore less sensitive to interest rates) as a hedge against a significant slowdown in economic activity.
