Q1 2022 Market Overview
Market Recap
The first quarter proved a volatile ride for investors as all major equity market indices finished in negative territory. While March offered a brief reprieve, the S&P 500 decline -4.60% for the quarter, while the global MSCI ACWI slide -5.36%.[1] Particularly hard hit were growth stocks which struggled in the face of elevated inflationary factors, rising interest rates, and the expectation of slowing economic growth. As a result, the tech-heavy Nasdaq Composite swiftly entered bear-market territory in early March, dropping 20% from a November peak before finishing the quarter down (-8.95%).[2] Some noteworthy index constituents declined even more for the quarter – Meta Platforms (-33.2%), Netflix (-37.8%), and Adobe (-19.65%).
Entering the year, we expected increased market volatility, tapering global growth, and tightening monetary policy. On the positive front, several compelling factors were present: COVID’s impact was dissipating, pent-up consumer demand, solid household and corporate balance sheets, and unemployment at pre-pandemic lows. Furthermore, expectations for improving economic growth outside the U.S and historically attractive valuations provided support for international stocks. Overall, despite a moderating environment, it still exhibited the overall characteristics for favorable equity market returns.
Unfortunately, the investment environment proceeded to deteriorate rapidly over the quarter and was exacerbated by Russia’s unprovoked invasion of Ukraine. While the global community swiftly denounced the invasion and took the necessary initial step of financial sanctions on Russia, it has transformed to an environment of heightened economic uncertainty. As a consequence, stubbornly high inflation is likely to persist, supply chains disruptions will be prolonged, and global growth will moderate further. The Eurozone is the most directly impacted by the tragedy in Ukraine, as the imposed sanctions cast a growing storm cloud over the region. The region is extremely dependent on Russia’s supply of energy and commodities, which likely exacerbates inflationary factors and poses significant downside risk to growth. European companies appear particularly vulnerable to higher costs that impact margins, while U.S. companies appear better positioned. In response, we reduced the risk profile of portfolios during the quarter to neutral by trimming non-U.S. equities.
The highly anticipated tightening shift in monetary policy began in March when the Federal Reserve announced a .25% increase to its benchmark federal-funds rate, representing the first increase since cast a growing storm cloud over the region. The region is extremely dependent on Russia’s supply of energy and commodities, which likely exacerbates inflationary factors and poses significant downside risk to growth. European companies appear particularly vulnerable to higher costs that impact margins, while U.S. companies appear better positioned. In response, we reduced the risk profile of portfolios during the quarter to neutral by trimming non-U.S. equities.
The highly anticipated tightening shift in monetary policy began in March when the Federal Reserve announced a .25% increase to its benchmark federal-funds rate, representing the first increase since December 2018.[1] Elevated inflation and the Ukraine invasion further complicate the Fed’s policy stance stoking the fear of higher prices for an extended period. A protracted high inflationary environment increases the probability of a more aggressive Fed policy response that runs the risk of curtailing subsequent economic growth sooner. All eyes remain focused on the path of Fed policy over the ensuing months.
The combination of slowing global growth and higher inflation creates a recipe for volatility as asset prices adjust to the changing landscape. Our overall neutral posture reflects the heightened level of uncertainty and implications of tighter monetary policy as the economic cycle matures. Given the events over the prior weeks, geopolitical risks have returned to the fore and added to the list of uncertainties.
Looking forward, we expect above average volatility as market participants recalibrate the moderating economic environment and the path of monetary policy. We believe it is precisely times like these that illuminate the critical goal of adhering to our sound process and judgment. Overall, our allocation views acknowledge the reality of slower growth and tightening monetary policy but stop short of positioning for an imminent recession. While the data and environment has become increasingly more uncertain, we will continue to adhere to our process and adapt as new data and evidence become available.
Worst Quarter for Bonds since 1980
Particularly challenging during the quarter was the rapid ascent of interest rates. The yield on the 10-year US Treasury rose .82% to end the quarter at 2.38%.[1] As the chart below highlights, the bond market appears to have priced in an aggressive interest path in a mere few short weeks, sending bond prices falling. As a result, the Bloomberg U.S. Aggregate Bond Index declined -5.93%, posting its worst quarter in more than 40 years.[2] No bond segments were immune, as evidenced by the conservative area of short duration investment grade municipal bonds declining -3.56%.[3] As a result, bond allocations moved in tandem with equity markets providing little ballast to offset the equity market declines during the quarter.
Despite the sell-off in bonds, we increased portfolio allocations to high-quality, short duration bonds during the quarter. We continue to emphasis flexible and opportunistic bond strategies with an overall shorter duration. Given an environment of slowing growth and the overall strength of corporate balance sheets, we remain overweight corporate credit.
[1] Morningstar Direct
[2] Morningstar Direct
[3] Ned Davis Research
[4] Morningstar Direct
[5] Morningstar Direct
[6] Bloomberg Municipal Bond 3 Year Index - Morningstar Direct
Disclosures:
All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability, or completeness of, nor liability for, decisions based on such information and it should not be relied on as such. The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.
No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. All investments include a risk of loss that clients should be prepared to bear. Different types of investments involve varying degrees of risk and there can be no assurance that any specific investment will either be suitable or profitable for a client’s investment portfolio. Economic factors, market conditions and investment strategies will affect the performance of any portfolio, and there are no assurances that it will match or outperform any benchmark. Asset Allocation may be used in an effort to manage risk and enhance returns. It does not, however, guarantee a profit or protect against loss.
New World Advisors, LLC ("New World") is a Registered Investment Advisor ("RIA") with the U.S. Securities and Exchange Commission (“SEC”). New World provides investment advisory and related services to clients nationally. New World will maintain all applicable notice filings, registrations and licenses as required by the SEC and various state regulators in which New World conducts business. New World renders individualized responses to persons in a particular state only after complying with all regulatory requirements or pursuant to an applicable state exemption or exclusion.