The market hates uncertainty and we got a healthy dose of it in the first quarter of 2022.
The year began with tepid optimism that the Omicron variant would fade, and a reopening worldwide economy would modestly push equities forward despite anticipated higher inflation and an accompanying hike in interest rates by the Federal Reserve. On February 24th, all economic and market forecasts for 2022 and beyond were upended when Russia invaded Ukraine, setting off coordinated economic sanctions and creating uncertainly from a region that accounts for 14% of corn and 13% of wheat production GLOBALLY! The nearby diagram shows the percentage of global commodities supplied by Russia and Ukraine.
Source: 1Q JP Morgan Guide to the Markets
Market volatility caught most investors off guard, as the S&P 500 lost 13% at one point before rebounding to finish the first quarter down just 4.6%. To put that in perspective, the largest market decline in all of 2021 was just 5%. The average intra-calendar year drawdown over the last 42 years is 14%, so if this was the worst for 2022, we were very close to historical averages.
The Federal Reserve has been given the impossible task of stunting inflation that currently headlines at 7.9% without stalling an economy that is facing the headwinds of global economic sanctions, continued supply chain delays, and a worker shortage. Its first step was a 25-basis point (0.25%) rate hike in Q1, with six more rate hikes expected to push the Fed Funds rate to 1.9% by the end of the year. Not coincidentally, the 30-year mortgage rate rose from 3.33% on 12/31 to 4.8% by 3/31. This should cool a housing market that had been sizzling hot and help slow the rate of inflation. It turns out stock investors weren’t the only losers in Q1. Bond investors lost more, down 5.9% due to rising and forecasted higher interest rates.
The standout asset class was commodities, which rose 25.5% due to the previously mentioned economic sanctions and disruptions from the Russia-Ukraine conflict and continued global supply chain issues.
Despite the dreadful headlines, the U.S. has essentially recovered from the COVID-19 pandemic in most economic respects. Compared to the same week of 2019, total credit/debit card transactions are up 31%, while dining is down just 3% and hotel stays are just 6% below 2019. TSA traffic is still down 11%, but less on weekends, implying that reduced business travel may stick around long term. We have mentioned the hot job market before, but the gap of job openings (11.3 million) to unemployed workers (5.5 million) keeps widening as businesses struggle to keep up with demand or ready themselves for future expansion. If you are a salaried employee, there has been no better time to gauge your value. If you are a business owner, it has never been harder to find capable and cost-effective employees.
European and Chinese stocks lagged the U.S. once again for very different reasons. The 27 members of the European Union buy 25% of their oil and 40% of their gas from Russia, making negotiations particularly delicate for those countries. China is just now experiencing its Omicron variant wave and continuing to respond with 100% lockdowns of Shanghai and other regions. These have tempered oil prices given the short-term drop in consumption but will likely prevent China from hitting its 5.5% annual GDP goal. Thus, international markets look cheap today, but need to be navigated carefully on a country-by-country basis.
Summary
The first quarter gave us a reminder of how important diversified portfolios can be in a time that brings higher inflation, increased equity volatility and bond declines. Perhaps this is the beginning of the end of the 40-year post-cold war period of globalization characterized by declining interest rates, low inflation and sustained economic expansion. We will continue to monitor your portfolios and the dynamic macro-economic, geopolitical and legislative factors which influence them and respond accordingly.