From the opening days of 2022, investors were taken on a wild ride during the first quarter that featured wide swings in stock, bond, and commodity markets around the world. Broad market volatility began to pick up in the first few days of 2022 as inflation readings hit multi-decade highs, prompting Federal Reserve officials to signal that interest rates will rise faster than the markets had previously thought during their January meeting. Just as the markets seemed to be stabilizing in February, the war in Ukraine started, oil and other commodity prices soared and the domestic equity markets fell into correction territory, losing over 10% from all-time highs. While stocks mounted a strong rebound in March, all the major market indexes posted negative returns for the first quarter, albeit the S&P 500 Index and the Dow Jones Industrial Average posted milder losses compared to the Nasdaq and Russell 2000 as investors rotated out of highly valued growth-oriented stocks into the more fairly valued sectors of the market. Large-cap stocks outperformed small- and mid-cap, which is to be expected in the times of geopolitical uncertainty and rising interest rates.
Only two sectors of our domestic economy finished the first quarter with a positive return. Energy was a clear winner, benefitting from the surge in oil and natural gas prices in response to Russia’s war against Ukraine, and the traditionally defensive utilities sector also posted a positive return. Laggards included communications, technology, and consumer discretionary.
Despite some outperformance early in the quarter, the international and emerging markets also got hit by the geopolitical uncertainty which erased the modestly positive performance of MSCI EAFE Index in January.
Bonds registered some of the worst performance in years during the first quarter of 2022 as high inflation and the threat of numerous future Fed rate hikes weighed on fixed income products. Bond yields moved higher throughout the quarter with the benchmark 10-Year Treasury yield rising from 1.5% in the beginning of the year to 2.3% by the end of March. Yield spreads have fallen sharply in 2022 and parts of the curve have either already inverted or are close to inversion. This may indicate an impending economic slowdown, although it did not materialize over the last few times the yield curve inverted through the past years.
Our domestic economy remained on solid ground, supported by a strong labor market and consumer demand. The state of the labor market was evidenced by the near record numbers of job openings while the unemployment rate fell to a record low of 3.6%. Consumer spending remained solid due to stimulus payments, job gains and wage growth.
The Federal Reserve has been communicating an ever increasingly hawkish message since December in their attempt to fight the highest inflation seen in the U.S. since the early 1980s. At their March 16th meeting, the Federal Reserve raised short-term interest rates by a quarter of a percent. It was the first interest rate hike since 2018, and it is anticipated to be the first of many in 2022 as the committee indicated there would be additional hikes at each of the six remaining meetings this year and an additional three more next year. Given the tighter monetary policy the Fed has laid out, officials have estimated that the U.S. will experience slower economic growth this year as rates increase and inflation remains elevated.
As we start a new quarter, headwinds from inflation, less accommodative monetary policy and geopolitical implications are among the uncertainties the markets are facing. Inflation still sits near a 40-year high, and it is unlikely that key inflation indicators like the Consumer Price Index will meaningfully decline anytime soon. The Federal Reserve reversed its accommodative stance and plans to unload the assets it acquired via quantitative easing in addition to interest rate hikes. Finally, the Russia-Ukraine war continues to rage on, and the geopolitical effects of it have spread beyond the battlefield, as relations between Russia and the West have hit the post-Cold War lows. The crippling economic sanctions against Russia keep pushing the prices for commodities up, increasing the chances for a material global economic slowdown.
But while clearly there are risks to the markets as we start the new quarter, it is important to remember that the U.S. economy is very strong and unemployment remains historically low, and that reality is supporting the equity markets. As for interest rates, they are remaining far below the levels where, according to most economists, they will slow the economy. In addition, consumer spending is robust and corporate and personal balance sheets are in good shape. So, while continued market volatility is expected, there are multiple positive factors that support the market, and it is important to remember that a well-executed and diversified long-term financial plan can overcome short periods of intense volatility. Keeping a proper balance of growth and income generating assets to fit your personal objectives within the boundaries of your risk tolerance remains the best way to achieve your financial goals.
Dumont & Blake Investment Advisors, LLC
March 31, 2022