2022 has proven to be an incredibly volatile year so far for the markets. Between the acceleration of inflation that started in late 2021, rising interest rates, declining stock and bond markets, and the tragic war in Ukraine, investors have seen scant signs of good news. While much of this data appears to be grim, it is critical to evaluate each aspect of the data thoroughly to determine what are true areas of concern and where we may be more optimistic. Below are a series of important financial and economic performance figures that are worth reviewing.
First, we start with equities. On an initial glance, stocks across the board have declined this past quarter. While this may be the case, there is some nuance here. The hardest hit segment of stocks has been U.S. growth stocks, down 12.38% YTD, as of 4/19/2022. This should not necessarily be surprising, given their record high stock prices last year. In addition, rising interest rates have caused valuations in all stocks, especially growth stocks, to contract since future earnings are discounted with a higher interest rate. Small-caps and international stocks do not appear immune to this decline as well. However, value stocks look to be weathering these price drops well relative to other equities. They are actually up .06% YTD, a possible result of value’s large discount in price compared to its growth peers over the past decade or so.
Equities are not the only asset class feeling the pain. Fixed income (as measured by the Bloomberg US Aggregate Bond Index) have also performed poorly, down 9.37% YTD. This is surprising, given that historically equities and fixed income have not had as highly correlated returns as we are seeing now. The main story here is rising interest rates and the Fed’s clear dedication to continued short-term rate hikes. These short-term benchmark rate hikes can ripple out to longer dated bonds as well. A of 4/19/2022, 10-Year Treasury yields have jumped to 2.8872%, while 30-Year fixed rate mortgage rates have increased to 5.27%. This is a level not seen since 2011 and represents an astonishing 61.16% spike in mortgage rates over just 4 months.
As a reminder, when interest rates increase, the value of most bonds decrease. This is largely why we are seeing such underperformance in fixed income. Therefore, this is a case of pure interest rate risk and not concerns about defaults. This can be seen in J.P. Morgan’s research into the effect of interest rate hikes and specific fixed income returns. As seen below, so far this year, most fixed income has been punished by rising rates, but not in equal measure. As of 3/31/2022, long dated high-quality bonds, like 30 Year Treasuries, have declined the most (down 11.41% YTD) while riskier High Yield bonds (down only 4.84% YTD) and Leveraged Loans (floating rate high yield debt, down a negligible .01% YTD) have fared better.
Source: J.P. Morgan
This confidence in the lower-quality end of the debt spectrum could be a promising sign to the economy, signaling that at the moment, there is not a fear of any major credit event like a mass default. In addition, there are more silver linings in the bond market. While this year so far has been disappointing for fixed income, historically this type of poor performance has been followed by strong returns as the markets stabilize over time. This is evident in BlackRock’s research going back to 1926, seen here.
Finally, there are some other headwinds hampering the overall market’s performance. Top of mind for many is inflation. Labor Department data for the Consumer Price Index (CPI) released on 4/12/2022 indicate that inflation increased 8.5% YoY, the highest amount since 1981 and above consensus estimates. However, core CPI which excludes volatile food and energy costs, rose 6.5%, in-line with estimates. This leads some to believe inflation may finally be peaking. Inflationary pressure is evident in the performance of several commodities, notably gold (up 7.01% YTD, as of 4/19/2022) and oil (up 38.85% YTD, as of 4/19/2022), although oil is well off its highs back in early March.
Both fixed income and equity markets are in a correction but not a bear market at this time. However, it is critical to look for areas of hope when markets perform poorly. On the equity front, while stocks are generally down across the board, the degree of the decline is not uniform. Value stocks have performed well relative to growth and may finally be moving into favor with a market that has not liked them for over a decade-long period. In addition, while growth stocks have declined, the other side to this is that they are now trading at more normal multiples for growth companies. For fixed income, interest rate hikes have been painful but do not point to systemic credit concerns. Instead, lower-credit, higher-yielding bonds have fared this bond market decline decently well, suggesting that the market is not concerned about worsening credit conditions. Finally, it is important to note that downturns in markets are concerning but a normal part of long-term investing. While the downturns of this quarter hurt, eventually they become a barely noticeable blip to the well-diversified buy-and-hold investor.
For investors with long time horizons, such as many of our clients, the best strategy during challenging times is to avoid impulsive decisions and only adjusting your allocation if your risk appetite or investment objectives have changed. For our retired clients, it is critical to make sure that your asset allocation is in-line with your objectives and risk tolerance, in addition to having ample liquidity to weather any financial storm. Regardless of your objectives, risk tolerance, and time horizons, the chart below from BlackRock should give solace to the concerned investor. It clearly shows the benefits of staying invested and keeping a level head even in the face of uncertainty.
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liquidity to weather any financial storm. Regardless of your objectives, risk tolerance, and time horizons, the chart below from BlackRock should give solace to the concerned investor. It clearly shows the benefits of staying invested and keeping a level head even in the face of uncertainty.