The Perfect Storm
The sobering start to 2022 saw pervasive weakness across multiple fronts during the first quarter: the economy, fixed income markets and equity markets. While we have not yet seen the official results regarding second quarter performance of the U.S. economy, results are in for the financial markets. Like those seen for the first quarter, the financial markets depict a perfect storm across major asset classes. Equities took the hardest hit as they saw a return of -15.7% for the period as measured by the MSCI ACWI Index of global markets. And like the first quarter, geography mattered little as both domestic and foreign equities succumbed to the forces pushing markets lower. Fixed income saw better, albeit still negative, performance for the quarter as core fixed income indices saw returns of approximately -4.6%. Even asset classes that have historically performed well in periods of strong inflation declined over the three-month period as both gold and broad commodity indices registered declines.
Given the degree of the declines experienced in the fixed income and equity markets, numerous pundits and prognosticators were quick to point out just how severe the first half declines were for investors. One firm revealed that the first half of 2022 saw intermediate term U.S. Treasuries deliver a negative return of a magnitude not seen since 1788. For equities, numerous outlets pointed out that the Standard & Poor’s 500 Index had just experienced the worst first half of a year since 1970.
To provide some perspective, it is worth noting that that the 10-year U.S. Treasury yield has declined since peaking on June 14, and in the second half of 1970, the Standard & Poor’s 500 Index delivered a total return of 29.1%. Of course, we don’t know precisely how major indices will end the year but once again, it is informative and useful to have historical perspective.
Abating or Gathering?
As we evaluate the economy and markets at the midpoint of 2022, our focus is on how developments may unfold throughout the remainder of the year. In this section of the Insight, we will focus on the economy and refer you to the other sections of this edition for specific insights on the fixed income and equity markets.
As referenced above, the U.S. economy experienced a GDP decline of 1.6% in the first quarter. As the second quarter began, it was widely felt that a rebound in economic activity would take place, resulting in GDP growth in-line with longer term expectations. What evolved over the course of the quarter, however, was lowered growth expectations by numerous economists. By the end of the three-month period, moderating growth expectations led several to lower their second quarter GDP forecasts to 2% or less.
A key contributor to the moderation in GDP growth is reduced demand— the virtual opposite of what transpired in 2020. As the pandemic intensified in 2020, all the stops were pulled out to offset the economic weakness induced by a COVID-led shutdown in the U.S. and global economies. In the U.S., the response was swift and multifaceted with mammoth stimulus provided on both the fiscal and monetary policy fronts.
While 2020 policy shifts elevated demand across a vast array of goods and services, it also contributed to the current state of the economy, which is
characterized by elevated inflation levels, dramatically reduced fiscal stimulus and monetary policy that is laser focused on reducing inflation. The Federal Reserve (Fed) is using two primary tools in an effort to rein in inflation: higher short-term interest rates (i.e., Fed Funds Rate) and a reduction of the Fed’s balance sheet. Inflation impacts attributable to Russia’s invasion of Ukraine and COVID lockdowns in China have heightened the Fed’s sense of urgency in responding to their efforts to lower the rate of inflation.
Demand destruction is evident in numerous pieces of economic data. First, consumer confidence has weakened substantially over the past few months, with the most recent reading of the University of Michigan Index of Consumer Sentiment hitting an all-time low. Additionally, the latest Expectations Index component of the Conference Board’s Consumer Confidence Index, which looks at consumers’ near-term outlook for income, business and employment conditions, fell to its lowest level since March 2013.
Also indicative of a cooling economy are the recent readings from the National Association of Home Builders (NAHB) Housing Market Index. The index is based on a survey of NAHB members and is designed to assess the health of the single-family housing market. After hitting a level of 90 in November 2020, the index now sits at a reading of 67; not a surprising result considering30-year mortgage rates have risen from2.7% in November 2020 to the current rate of 5.7%, and housing pricesincreased20.4% for the year ending April 30.
Given this backdrop the Fed, through their aforementioned policy levers, is attempting to engineer a “soft landing” for the U.S. economy. However, there is a growing probability of recession. This is due to a concern that the Fed will “overtighten” in its efforts to reduce inflation at a time when the economy is already slowing. If recession does occur, it will most likely occur after 2022 as labor market strength and relatively strong consumer balance sheets will keep growth at a positive level this year. But, as we have seen over the past couple years, economic conditions and policy reactions to those conditions can change quickly. We will diligently evaluate these developments and their prospective impact on our investment strategy.
Asset Allocation Overview
There were no changes in allocation implemented across our five investment objectives during the second quarter. We continue to maintain our neutral positioning across the various asset classes comprising each of our allocations, which range from exclusively fixed income at one end of the spectrum to the other end which focuses exclusively on domestic and international equities. Given the performance of the underlying asset classes, each objective delivered negative returns for the period.
While no changes were executed during the quarter, our Asset Allocation Committee continues to meet regularly to ensure our positioning across, and within, our five objectives is representative of our long-term outlook for the economic environment and financial markets.
In addition to our efforts at the allocation level, our team continuously evaluates the underlying holdings within our allocation and proprietary separately managed account strategies to ensure they are positioned properly and affirm we are structuring client portfolios in a way that will allow them to meet their financial goals and objectives.
In closing, given the significant moves made across asset classes so far this year, it is highly recommended that investors evaluate their current stated investment objective and ensure it continues to reflect their investment goals and risk tolerances.
Source: BTC Capital Management, Bloomberg LP, Ibbotson Associates, FactSet, Refinitiv.
The information provided has been obtained from sources deemed reliable, but BTC Capital Management and its affiliates cannot guarantee accuracy. Past performance is not a guarantee of future returns. Performance over periods exceeding 12 months has been annualized.
The information within this document is for information purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Statements in this report are based on the views of BTC Capital Management and on information available at the time this report was prepared. Rates are subject to change based on market and/or other conditions without notice. This commentary contains no investment recommendations and you should not interpret the statement in this report as investment, tax, legal, and/or financial planning advice. All investments involve risk, including the possible loss of principal. Investments are not FDIC insured and may lose value.