Economic Flash: Growth with Inflation Vs. No Growth

June 2022

US Economy: Supply chain repair.

A reduction in port congestion and shipping transit delays are early signs that supply chains are repairing. Still, China’s rolling Covid lockdowns/restrictions and Russia’s ongoing invasion of Ukraine dampen the possibility of a quicker recovery. The related high inflation helped drive US consumer confidence to a 3-month low (106.4).

US Stocks: Modest gains.

For the second time in 2022, US equities eked out generally positive monthly returns following a late May rally. Investors looked past disappointing earnings from major retailers to relatively good inflation news: The PCE Price Index, which measures core inflation (minus food and energy), fell to 4.9% annualized in May (from 5.2%) while consumer spending rose.

Foreign Stocks: China slows.

Non-US equities performed marginally better than US equities. While most major global economies are tightening monetary policy, China is loosening to counteract slowing growth (4% expected for 2022) and a sinking stock market (36% drop in past year). Stimulus and less restrictive Covid policy could lead the world’s 2nd largest economy to surprise on the upside.

Fixed Income: Rates fall.

The yield on 10-year US Treasury bonds fell in May after peaking above 3% on investor concerns that the Fed’s fight against inflation could lead to recession. As interest rates generally fell, bond prices strengthened, displaying for the first time in 2022 the defensive benefits of fixed income. Muni bonds outperformed given their perceived significant discount to US Treasuries.

Real Assets: Commodities run.

Real assets continued their strong run, with the energy sector (+10.4%) driving commodities prices higher. Infrastructure equities have also delivered incrementally positive returns, while the more cyclically sensitive REIT category has struggled given investor concerns about recession and rising corporate bond yields.

Alternatives: Hedging additive.

Hedge fund exposures have generally added value to portfolios in 2022. Unsurprisingly, long-biased equity managers had more success in May with the equity market recovering somewhat. Waning investor enthusiasm and tumult in the “stablecoin” market (crypto backed by assets) were factors in a difficult month for cryptocurrency and blockchain strategies.

Equities Total Return

U.S. Large Cap 0.2% (12.8%) (0.3%)
U.S. Small Cap 0.1% (16.6%) (17.0%)
U.S. Growth (2.3%) (22.1%) (7.6%)
U.S. Value 1.9% (4.8%) 0.3%
Int’l Developed 0.7% (11.3%) (10.4%)
Emerging Markets 0.4% (11.8%) (19.8%)

Fixed Income Total Return

U.S. Agg. Bond 0.6% (8.9%) (8.2%)
TIPS (1.0%) (5.9%) (1.4%)
U.S. High Yield 0.3% (7.8%) (5.0%)
Int’l Developed (1.2%) (7.4%) (7.2%)
Emerging Markets 0.1% (3.0%) (1.5%)
Intermediate Munis 1.5% (5.3%) (5.2%)
Munis Broad Mkt 1.6% (7.5%) (6.8%)


Non-Traditional Assets Total Return

Commodities 1.5% 32.7% 41.9%
REITs (4.7%) (13.0%) 4.1%
Infrastructure 3.7% 7.8% 12.5%
Hedge Funds
Absolute Return (1.1%) (0.1%) 0.1%
Overall HF Market (1.1%) (3.3%) (3.0%)
Managed Futures (0.3%) 19.1% 17.3%

Economic Indicators

MAY-22 NOV-21 MAY-21
Equity Volatility 26.2 27.2 16.8
Implied Inflation 2.7% 2.5% 2.4%
Gold Spot $/OZ $1837.4 $1775.0 $1906.9
Oil ($/BBL) $122.8 $71.0 $69.3
U.S. Dollar Index 118.5 115.0 111.2

Glossary of Indices

Our Take

A month that ended with meager net positive returns possibly feels more like relief to investors than a signal that financial markets are likely to turn things around. While some economic data indicates continuation of the post-Covid recovery (low unemployment, rising wages, excess cash), a fair amount of data on the other side of the ledger limits that enthusiasm.

It remains to be seen whether the contraction in Q1 US GDP reverses in the coming quarters. If growth resumes, a robust pace would be surprising. Inflation is arguably easing but not at a rate that is likely to be cheered by consumers, with indications that disruptions to the supply chain will last at least into 2023. That said, US consumers have been surprisingly resilient in the face of rising costs with spending accelerating. But that has primarily been fueled by swiftly rising credit card debt, a resource that cannot be tapped in perpetuity. Additionally, future spending may be impaired as the higher cost of necessities — food, energy, shelter — crowds out discretionary purchases.

Looking Ahead

Given this backdrop, and consistent with the market regime thesis we presented in January, market volatility is likely to continue at above average levels as we move into the second half of 2022. In terms of what we are watching most closely, tightening liquidity and credit conditions are often the precursor to more difficult environments. Currently, the yield differential between lower-quality US corporate bonds and US Treasuries has widened to levels we haven’t seen since 2020, and the Fed has announced it will drain liquidity by reducing its balance sheet at a pace of $47.5 billion per month. Just as important, we will be monitoring whether the Fed’s cumulative actions appear to be pulling down inflation and for stabilization in interest rates.

While most investors tend to dwell on the negative in difficult market environments, these times are often when we are capable of making our best and most impactful investments on a strategic basis. For example, valuations are attractive in many asset classes including international equities and municipal bonds. Additionally, the banking of tax-losses and rebalancing portfolios to targets will allow us to position for success in the long run. During extended periods of high market volatility, one of our most important roles as advisors is to keep clients on plan and focused on the big picture.