July 2022
US Economy: Inflation stings.
Despite some bright spots, including the still strong US labor market, weakening across manufacturing, real estate and consumer spending indicated the growth-throttling impact of inflation and Fed tightening: Mortgage applications and home sales fell in June, as consumer sentiment hit an all-time low (50.0) and retail sales slowed (-0.3).
US Stocks: Earnings a concern.
US equities stabilized in the 2nd half of June but finished down to nearly match the worst monthly return for 2022. Earnings growth has cooled and forward earnings guidance has turned generally negative. With a potential recession top-of-mind for investors, commodity-sensitive energy (-16.8%) and materials (-13.9%) were the weakest sectors.
Foreign Stocks: China rebound.
Emerging market stocks were buoyed somewhat by a rebound in China (+6.6%), following its emergence from Covid lockdowns and less concern about a crackdown on tech companies. China is the only major economy globally implementing pro-growth policies such as tax cuts, infrastructure spending and lower interest rates.
Fixed Income: Fed tightens more.
The Fed surprised markets by raising its key interest rate 75 basis points, with more such increases possible. After the Fed announcement, the 2-year US Treasury yield surged from 2.5% to 3.5% before falling back to 2.9%. That rates came back down suggests investors believe the Fed will get inflation under control, even at the cost of recession.
Real Assets: Commodities dive.
On recession concerns, commodities were the worst-performing sector across financial markets and the real asset category. Losses were broad with industrial metals, energy and agricultural commodities falling 16%, 15% and 9%, respectively. US gas prices remain elevated but are down 15 cents from the mid-June high of $5.47/gallon.
Alternatives: Softening the blow.
Hedge fund exposures have continued to benefit portfolios by dampening losses. That said, 2022 has been a modest reprieve for managed futures strategies, which generally benefit from persistent market trends in a broad array of commodity and financial derivatives. Such strategies may struggle (and generally have) for years before posting an outsized gain.
Equities Total Return
| JUN | YTD | 1 YR | |
|---|---|---|---|
| U.S. Large Cap | (8.3%) | (20.0%) | (10.6%) |
| U.S. Small Cap | (8.2%) | (23.4%) | (25.2%) |
| U.S. Growth | (7.8%) | (28.2%) | (19.8%) |
| U.S. Value | (8.8%) | (13.2%) | (7.5%) |
| Int’l Developed | (9.3%) | (19.6%) | (17.8%) |
| Emerging Markets | (6.6%) | (17.6%) | (25.3%) |
Fixed Income Total Return
| JUN | YTD | 1 YR | |
|---|---|---|---|
| Taxable | |||
| U.S. Agg. Bond | (1.6%) | (10.3%) | (10.3%) |
| TIPS | (3.2%) | (8.9%) | (5.1%) |
| U.S. High Yield | (6.8%) | (14.0%) | (12.7%) |
| Int’l Developed | (1.5%) | (8.8%) | (8.9%) |
| Emerging Markets | (0.5%) | (3.5%) | (2.1%) |
| Tax-Exempt | |||
| Intermediate Munis | (0.5%) | (5.8%) | (5.7%) |
| Munis Broad Mkt | (1.9%) | (9.3%) | (8.9%) |
Non-Traditional Assets Total Return
| JUN | YTD | 1 YR | |
|---|---|---|---|
| Commodities | (10.8%) | 18.4% | 24.3% |
| REITs | (7.1%) | (19.2%) | (5.9%) |
| Infrastructure | (7.7%) | (0.5%) | 5.6% |
| Hedge Funds | |||
| Absolute Return | (0.7%) | (0.7%) | (1.0%) |
| Overall HF Market | (1.5%) | (4.8%) | (4.8%) |
| Managed Futures | 2.3% | 21.9% | 21.5% |
Economic Indicators
| JUN-22 | DEC-21 | JUN-21 | |
|---|---|---|---|
| Equity Volatility | 28.7 | 17.2 | 15.8 |
| Implied Inflation | 2.3% | 2.6% | 2.3% |
| Gold Spot $/OZ | $1807.3 | $1829.0 | $1770.1 |
| Oil ($/BBL) | $114.8 | $78.0 | $75.1 |
| U.S. Dollar Index | 120.6 | 115.8 | 111.2 |
Our Take
The first half of 2022 was one of the worst starts of the year in stock market history. The high-profile stocks of the pandemic era, including Netflix, Nvidia, Meta, are each down more than 45% in the past six months. In fact, 40% of the drop in the S&P 500 in the first half was due to the 10 largest stocks on the index, highlighting both the value of diversification and how yesterday’s winners can turn into losers as the market expectations change.
Investors’ focus has shifted over the last few months from the causes of inflation (tight labor markets and supply chain shocks, loose monetary policy and government spending) to the impact of inflation on US consumers. The data on that front do not paint a rosy picture. As noted earlier, inflation and the Fed’s response have started to take a toll on consumer spending. Even potential positives, such as falling real estate prices, are not likely to make housing more affordable given the highest mortgage rates since the 2008 global financial crisis and low vacancy rates driving up rents.
Looking Ahead
We would not be too surprised if the US economy is actually in the midst of a recession, given that 1st quarter GDP shrank and could also be negative for the 2nd quarter (recession is defined as two consecutive quarters of negative GDP growth). The severity of recessions can and does vary, notwithstanding the deep downturns that followed the bursting of the Internet (2000) and real estate bubbles (2008). In any case, recessions are a natural part of the business cycle, have lasted historically (since World War II) less than a year, and aren’t necessarily marked by long-lasting negative returns in the stock market. Over the last 100 years, the equity market has peaked around six months before a recession began, as recessions are typically priced in before we even get there.
If not recession, we could be facing stagflation in the near term. Two of the three elements of stagflation are already in place — relatively high inflation and low GDP growth – but fortunately we do not yet have rising unemployment. We are long-term investors who structure portfolios to navigate through full economic cycles, both expansionary and recessionary. If stagflation does turn out to be the path, with a higher demonstrated correlation to inflation, real assets are likely to remain a core component of our positioning. Within equities, our managers are likely to become more defensive, focused on essential goods and services that consumers buy even when they cost more.
