First Quarter 2022 Market and Economic Review

Market Review

On seemingly all fronts, there appears to be a storm brewing – or rain already falling – which has many investors seeking shelter. And markets around the world are reflecting that sentiment through the first three months of 2022.

For the quarter, virtually every asset class is down across the board. The lone exception is commodities, such as oil, which is propped up for the moment by sanctions placed upon Russia that have switched off supplies from that country. The world is also still trying to shake free from the Covid-induced slumber that has caused unprecedented supply chain issues and triggered the first significant inflationary period in over 40 years.

As a countermeasure to inflation in the U.S., the Federal Reserve announced an increase in interest rates in March. It’s expected to be the first of several such increases. The primary questions now are: how many increases will we see, and how high will the rates increase?

Conventionally, as economic environments encounter challenges, investors tend to pull back from higher-risk propositions. The Russell 2000 index, which measures trades of smaller U.S. company stocks, certainly reflects that thinking as it finished the quarter down 7.53-percent — a noteworthy drop for the index after gaining 14.82-percent for the year in 2021.

Large-cap companies did not fare much better. The S&P 500 (an index of the 500 largest U.S. public companies) fell 4.6-percent for the quarter. However, the last few weeks of March did see some positive rebounding to close out the quarter. The gains are mostly due to the Fed doing what was expected – a quarter-percent increase in the interest rate – which eased the minds of some investors who worried the increase may have been higher than expected.

Generally, when conditions are such that investors pull back from higher-risk investments and search for more conservative options, bonds become a popular haven. So far, that has not been the case this year. The Bloomberg U.S. Aggregate experienced a 5.93-percent decline in the first quarter steepening the downward trend these bonds experienced throughout last year. The drop is partially due to the sheer confusion caused by all the various influences on economies around the world. Interest rate hikes will also dampen bond investments as investors reposition assets out of low-yielding fixed-income instruments.

International markets, which are experiencing a heavier toll from Russia’s invasion of Ukraine than the U.S. is, were also down notably for the quarter. The MSCI EAFE (the index for developed nations in Europe, Australasia, and the Far East) finished the quarter down 5.79-percent. The drop is another disappointing turn for an index that had gained nicely in 2021 for parts of the world that are trying to come out from under some of the tightest Covid restrictions.

2022 Quarter 1 Market Performance Benchmarks

* Each benchmark is allocated based on the assumed Risk Profile of underlying indexes.

**Benchmarks include a mixture of ICE BofA US 3-month Treasury Bill Index, Bloomberg Global Aggregate X-US Index, Bloomberg US Aggregate Index, Bloomberg Multiverse Index., Bloomberg US Credit Index, MSCI EAFE Net Index, Value Line Composite Index (Geometric), and the Cboe S&P 500 BuyWrite Index. These benchmarks are the same as those in the Risk/Return and Account Analytics sections of client quarterly performance reports. By comparing your portfolio’s return to the benchmark with the closest risk/return characteristics, you get a more accurate reading of portfolio performance than using a less diversified benchmark, such as the S&P 500 index.

Economic Review

For much of the past year, the U.S. economy, along with much of the world, has experienced a steady rate of inflation. Primarily caused by supply chain disruptions, inventory shortages, and labor challenges, consumer goods and materials are simply hard to get.

As we had projected previously, it was only a matter of time before the Federal Reserve stepped in to apply some counter-inflation measures. Step one was for the Fed to begin tapering its purchases of Treasury bonds, but the more aggressive measure is for the Fed to start increasing its effective rate on Federal funds. On March 16, the first such rate hike was officially announced at 0.25-percent – the first such increase since December 2018.

Now the question remains, how many more increases will the Fed set, and at what rate? There is much speculation, but the popular consensus is projecting anywhere from 6 to 9 more increases into next year. Each of those increases could range from 0.25- to 0.5-percent but there is some chatter that hikes could be even higher.

Since the Federal funds rate has been anchored at nearly zero percent since the start of the Covid-19 pandemic (April 2020), a steady diet of increases of 25 to 50 basis points would put the interest rate in the range of 2.0- to 3.0-percent by year’s end. While these increases may seem significant to those who have become accustomed to the sub-1.0-percent rate we’ve enjoyed for most of the past 14 years, the increases actually put us right back to where they were headed in 2018 and 2019 before the pandemic shut down economies worldwide. It’s also worth noting that prior to the housing crisis and subsequent recession in 2008, the interest rate for most of 2006 and 2007 hovered right around 5.25-percent.

For now, many of the variables are in a state of flux and are responding to multiple influencers. The important thing to remember is that we constantly monitor all factors and will maintain investment moves that meet the risk/reward targets for each of our client portfolios. And we are happy to answer any questions you may have along the way.