4Q 2022 Recap & 1Q 2023 Outlook

Recapping A Challenging 2022

Markets faced several challenges in 2022, including high inflation, historic central bank policy, the war in Ukraine, and Covid lockdowns in China. Inflation was a major factor in the markets throughout the year, with the headline consumer price index reaching a 40-year high of 9.1% in June. High inflation prompted the Federal Reserve and its global central bank peers to aggressively raise interest rates, which caused stocks and bonds to trade lower. There was no place to hide as central banks rapidly tightened monetary policy. Figure 1 shows the S&P 500 returned -19.4% in 2022, its worst annual return since 2008, and Figure 5 shows the Bloomberg U.S. Bond Aggregate produced its worst total return since 1976. This letter reviews the fourth quarter, recaps a difficult 2022, and discusses what the market will be focused on in 2023.

Putting 2022’s Interest Rate Hikes Into Perspective

The main story of 2022 was the reversal of monetary policy from extraordinarily accommodative levels during the Covid-19 pandemic. Figure 2 shows the speed and size of interest rate increases as central banks worked to bring inflation under control. The chart tracks the cumulative percentage of interest rate increases and decreases by global central banks during rolling three-month periods since 1995. For example, the 68% at the end of November 2022 indicates that central banks across the globe raised interest rates by a total of 68% from September to November. In contrast, the total amount of interest rate cuts during that same period was only 4%. As the data shows, 2022 was the quickest, largest, and most imbalanced global tightening cycle since the late 1990s.

The pace of interest rate increases is forecasted to slow during 2023. Central banks continue to hint that they are approaching the end of their interest rate hike cycle, citing concerns that further tightening could push the economy into recession. In addition, data suggests price pressures are easing. While the year-over-year headline consumer price index rose by 7.1% in November 2022, which is still high compared to historical levels, it was down from the 9.1% rate seen in June 2022. As inflation and central bank policy return to normal, a new uncertainty is emerging – the unknown effects of 2022’s rate hikes.

Markets Wait for the Lagged Effect of Higher Interest Rates to Show Up in Economic Data

The Federal Reserve’s interest rate hikes occurred in 2022, but the full impact of its restrictive measures has not yet been fully felt in the real economy. While the U.S. economy contracted during the first half of 2022, it expanded at a robust +3.2% annualized pace during the third quarter. Consumer spending remained strong throughout most of 2022 despite high inflation, and the U.S. labor market added more than 4 million jobs through the end of November. The data indicates the U.S. economy has withstood tightening thus far, but the real test will come in 2023 as the cumulative impact of higher interest rates becomes clearer.

While a recession is not a foregone conclusion, it is possible the economy could be tested in 2023. An index of leading economic indicators shows the U.S. economy is already starting to slow as the impact of higher interest rates takes hold. Figure 3 graphs the month-over-month change in The Conference Board’s Leading Economic Index, which tracks ten economic components that tend to precede changes in the overall economy. Included in the components are the average weekly hours worked by manufacturing workers, new home building permits, and the volume of new orders for capital goods, such as equipment, vehicles, and machinery. The chart reveals that the Leading Economic Index has decreased every month since March 2022, an indication the economy is slowing after a period of strong growth during the pandemic recovery.

Equity Valuations Are More Attractive, But Corporate Earnings Are An Open Question

Whereas inflation and central bank policy were the primary drivers of markets in 2022, economic data and corporate fundamentals are expected to play a larger role in determining the market’s direction in 2023. Figure 4 tracks two important S&P 500 metrics. The top chart tracks the next 12-month price-to-earnings ratio, which divides the S&P 500’s projected next 12-month earnings by its current price. It shows valuation multiples expanded during the pandemic as interest rates were cut to near 0% before reversing lower during 2022 as rising interest rates weighed on company valuations.

While current valuations are at a more attractive starting point today than at the beginning of 2022, corporate earnings are an open question entering 2023 with the potential for an earnings reset as the economy slows. The bottom chart in Figure 4 tracks the S&P 500’s trailing 12-month earnings growth, showing the jump in corporate earnings during the pandemic. Despite expectations for an economic slowdown, Wall Street analysts still forecast single-digit earnings growth for the S&P 500 in 2023. The positive earnings growth forecast is encouraging, but it creates a risk for the market. If actual earnings growth falls short of the forecast, stock prices could decline as markets price in lower actual earnings.

Equity Market Recap – Stocks Trade Higher in 4Q’22

Stocks traded lower during December but still ended the fourth quarter higher. The S&P 500 Index of large cap stocks returned +7.6% during the fourth quarter, outperforming the Russell 2000 Index’s +6.2% return. The Dow Jones Index, which includes large companies such as Visa, Caterpillar, Nike, and Boeing, was the top performer, returning +15.9%, while the Nasdaq 100 Index of technology and other growth-style stocks produced a -0.1% return during the fourth quarter.

Energy was the top performing S&P 500 sector during the fourth quarter, followed by the cyclical sector trio of Industrials, Materials, and Financials. Defensive sectors, including Health Care, Consumer Staples, and Utilities, were middle of the pack performers. Growth-style sectors, including Technology, Communication Services, and Consumer Discretionary, and interest-rate sensitive Real Estate underperformed as higher interest rates continued to weigh on valuation multiples.

International stocks outperformed U.S. stocks during the fourth quarter. The MSCI EAFE Index of developed market stocks returned +17.7% during the fourth quarter, while the MSCI Emerging Market Index returned +10.3%. A weaker U.S. dollar boosted the returns of international stocks, with U.S. dollar weakness driven by a shrinking monetary policy gap as other central banks catch up with the Federal Reserve’s aggressive policy. Separately, China’s decision to relax its Covid-zero restrictions raised the prospect of stronger global growth as one of the world’s biggest economies reopens.

Bond Market Recap – The Great 2022 Yield Reset

The bond market experienced a significant resetting of interest rates during 2022, with yields steadily rising as the Federal Reserve pushed through large interest rate hikes. Despite posting positive returns during the fourth quarter, bonds produced significant losses during 2022 as central banks raised interest rates at a rapid pace. The top chart in Figure 5 shows the Bloomberg U.S. Bond Aggregate produced a -13% total return during 2022, its biggest negative total return since tracking began in 1976. The bottom two charts in Figure 5 examine the current state of the credit market after 2022’s rate hikes. The middle chart shows the 10-year Treasury yield sits at its highest level since 2007. Yields are now higher across most credit classes, and investors can earn a yield of around 4% to 5% on a portfolio of high-quality bonds, such as U.S. Treasury bonds and investment grade corporate bonds, without locking up capital for long periods of time. In the corporate credit market, the bottom chart shows the high-yield corporate bond spread, which is the extra yield investors demand to loan to lower quality borrowers, is in line with its median since 1999.

The starting point for bonds, both in terms of yield and credit spreads, is now more compelling than it has been in a long time. However, there is still the potential for continued volatility in the bond market. There is still significant uncertainty regarding how high the Fed will need to raise interest rates and how long it will need to keep interest rates at restrictive levels to bring inflation down to normal levels. There is a risk that inflation could remain above the Fed’s 2% target, leading to an extended tightening cycle. At the same time, the economy is likely to start feeling the effects of 2022’s rate hikes in 2023, which could make bonds more attractive. The crosscurrents of uncertain central bank policy and a volatile global economy could keep interest rate volatility elevated and test bond investors’ nerves again during 2023.

2023 Outlook – Turning the Page on 2022’s Historic Tightening Cycle

2023 brings the next phase of the tightening cycle where the lagged effects of tighter monetary policy will be felt. It has the potential to be a year of two halves. In the first half, the focus is likely to shift from the number of future interest rate hikes to how much those interest rate hikes will slow the economy. Some data, such as the housing market, indicate that tighter monetary policy is being transmitted into the economy at a rapid pace. Home sales are slowing, and homebuilder confidence weakened every month during 2022 and now sits at its lowest level since 2012. At the same time, consumers continue to spend, and employers continue to add jobs. There is still a wide range of possible outcomes, and the unique nature of the pandemic followed by rapid interest rate cuts and hikes makes the path forward less certain.

The second half has the potential to be different depending on how severe the slowdown is in early 2023. Markets are based on forward-looking decisions, and investors will be watching closely for signs that the economy has bottomed and is recovering. Plus, Figure 1 contains an encouraging historical trend. The chart shows there have only been two instances of consecutive negative S&P 500 return years since 1950, in 1973-1974 and 2000-2002. This does not necessarily mean the S&P 500 will produce a positive return in 2023 or trade higher in a straight line from here, because it may not. However, it does provide helpful historical context in a volatile environment.

Wishing you and your family happiness and health in the New Year! We look forward to serving you another year.

Important Notices & Disclaimer

The information and opinions expressed herein are solely those of PFG Private Wealth Management, LLC (PFG), are provided for informational purposes only and are not intended as recommendations to buy or sell a security, nor as an offer to buy or sell a security. Recipients of the information provided herein should consult with their financial advisor before purchasing or selling a security.

The information and opinions provided herein are provided as general market commentary only, and do not consider the specific investment objectives, financial situation or particular needs of any one client. The information in this report is not intended to be used as the primary basis of investment decisions, and because of individual client objectives, should not be construed as advice designed to meet the particular investment needs of any investor.

The comments may not be relied upon as recommendations, investment advice or an indication of trading intent. PFG is not soliciting any action based on this document. Investors should consult with their financial adviser before making any investment decisions. There is no guarantee that any future event discussed herein will come to pass. The data used in this publication may have been obtained from a variety of sources including U.S. Federal Reserve, FactSet, Bloomberg, Bank of America Merrill Lynch, iShares, Vanguard and State Street, which we believe to be reliable, but PFG cannot be held responsible for the accuracy of data used herein. Any use of graphs, text or other material from this report by the recipient must acknowledge MarketDesk Research as the source. Past performance does not guarantee or indicate future results.   Investing   involves   risk,   including   the possible loss of principal and fluctuation of value. PFG disclaims responsibility for updating information. In addition, PFG disclaims responsibility for third-party content, including information accessed through hyperlinks.

No mention of a particular security, index, derivative or other instrument in the report constitutes a recommendation to buy, sell, or hold that or any other security, nor does it constitute an opinion on the suitability of any security, index, or derivative. The report is strictly an information publication and has been prepared without regard to the particular investments and circumstances of the recipient.

READERS   SHOULD   VERIFY   ALL   CLAIMS   AND   COMPLETE    THEIR    OWN RESEARCH AND CONSULT A REGISTERED FINANCIAL PROFESSIONAL BEFORE INVESTING IN ANY INVESTMENTS MENTIONED IN THE PUBLICATION. INVESTING IN SECURITIES AND DERIVATIVES IS SPECULATIVE AND CARRIES A HIGH DEGREE OF RISK, AND READERS MAY LOSE MONEY TRADING AND INVESTING IN SUCH INVESTMENTS.

PFG Private Wealth Management, LLC is a registered investment advisor.

Putting Context Around Recent Stock Market Volatility

Stock market volatility is rising this year after a relatively calm 2021. Financial markets are experiencing bigger moves up and down as investors navigate a long list of events, including Federal Reserve interest rate hikes, heightened geopolitical risk, and 40-year high inflation readings. This month’s chart provides historical context around stock market volatility and discusses how to think about your portfolio during periods of increased volatility.

Figure 1 charts the S&P 500 Index’s daily price return since 1970 and overlays the top 30 and bottom 30 days. There are two important takeaways. First, the best and worst trading days historically occur in clusters. Second, timing the market is almost impossible due to the close proximity of good and bad days. As an example, earlier this month the S&P 500 registered its 15th biggest daily return since 1970 after the latest inflation data suggested price pressures may be easing. The +5.5% S&P 500 return on November 10th followed volatile trading during September and October and demonstrates how market volatility occurs in groups.

What can you do to improve the chances of achieving your long-term goals? As always, our team recommends staying balanced and diversified. Different asset classes react to market conditions in different ways. Diversification spreads your investments around so your exposure to, and the potential impact from, any one type of asset is limited. More importantly, focus on the long-term rather than day-to-day price swings. History indicates lengthening your time horizon increases the odds in your favor. Should you have any concerns around market volatility, don’t hesitate to reach out to our team.

Important Notices & Disclaimer

The information and opinions expressed herein are solely those of PFG Private Wealth Management, LLC (PFG), are provided for informational purposes only and are not intended as recommendations to buy or sell a security, nor as an offer to buy or sell a security. Recipients of the information provided herein should consult with their financial advisor before purchasing or selling a security.

The information and opinions provided herein are provided as general market commentary only, and do not consider the specific investment objectives, financial situation or particular needs of any one client. The information in this report is not intended to be used as the primary basis of investment decisions, and because of individual client objectives, should not be construed as advice designed to meet the particular investment needs of any investor.

The comments may not be relied upon as recommendations, investment advice or an indication of trading intent. PFG is not soliciting any action based on this document. Investors should consult with their financial adviser before making any investment decisions. There is no guarantee that any future event discussed herein will come to pass. The data used in this publication may have been obtained from a variety of sources including U.S. Federal Reserve, FactSet, Bloomberg, Bank of America Merrill Lynch, iShares, Vanguard and State Street, which we believe to be reliable, but PFG cannot be held responsible for the accuracy of data used herein. Any use of graphs, text or other material from this report by the recipient must acknowledge MarketDesk Research as the source. Past performance does not guarantee or indicate future results.   Investing   involves   risk,   including   the possible loss of principal and fluctuation of value. PFG disclaims responsibility for updating information. In addition, PFG disclaims responsibility for third-party content, including information accessed through hyperlinks.

No mention of a particular security, index, derivative or other instrument in the report constitutes a recommendation to buy, sell, or hold that or any other security, nor does it constitute an opinion on the suitability of any security, index, or derivative. The report is strictly an information publication and has been prepared without regard to the particular investments and circumstances of the recipient.

READERS   SHOULD   VERIFY   ALL   CLAIMS   AND   COMPLETE    THEIR    OWN RESEARCH AND CONSULT A REGISTERED FINANCIAL PROFESSIONAL BEFORE INVESTING IN ANY INVESTMENTS MENTIONED IN THE PUBLICATION. INVESTING IN SECURITIES AND DERIVATIVES IS SPECULATIVE AND CARRIES A HIGH DEGREE OF RISK, AND READERS MAY LOSE MONEY TRADING AND INVESTING IN SUCH INVESTMENTS.

PFG Private Wealth Management, LLC is a registered investment advisor.

Wage Inflation Puts Additional Pressure on the Federal Reserve

Inflation remains a closely watched topic in financial markets. Core inflation, which excludes volatile food and energy prices, increased +6.6% year-over-year during September. It was the fastest annual pace since August 1982 and signals inflation’s persistence. Early inflation pressures were attributed to clogged supply chains and strong demand overwhelming limited supply, but a new source of inflation is gaining attention as supply chains normalize – wage inflation.

Figure 1 shows hourly wages increased +5% year-over-year during September. The growth rate, which is significantly above the pre-pandemic trend, indicates labor demand is outpacing labor supply and employers are paying more to attract and retain workers. What is causing the labor supply / demand imbalance? Data shows millions of workers left the labor market during the pandemic and have not returned.

Figure 2 graphs the number of people not in the labor force, which is defined as persons who are neither employed nor unemployed. This category includes retired persons, students, individuals taking care of children or other family members, and others who are neither working nor seeking work. The chart shows 95 million individuals were not in the labor force at the end of February 2020. The number spiked to 103.5 million at the end of April 2020 as workers left the labor market due to virus and health concerns, childcare responsibilities, and early retirements. While some of those individuals returned to the labor market, there are nearly 5 million more people not in the labor force at the end of September 2022.

Wage inflation is yet another factor complicating the Federal Reserve’s goal to bring under inflation control. Bringing the labor market back into equilibrium could ease wage inflation, but it could also significantly increase unemployment. Despite the near-term employment risk, the Fed views the risk of inflation becoming entrenched as a bigger long-term risk. All eyes will be on the labor market in coming months.

The information and opinions expressed herein are solely those of PFG Private Wealth Management, LLC (PFG), are provided for informational purposes only and are not intended as recommendations to buy or sell a security, nor as an offer to buy or sell a security. Recipients of the information provided herein should consult with their financial advisor before purchasing or selling a security.

Important Notices & Disclaimer

The information and opinions expressed herein are solely those of PFG Private Wealth Management, LLC (PFG), are provided for informational purposes only and are not intended as recommendations to buy or sell a security, nor as an offer to buy or sell a security. Recipients of the information provided herein should consult with their financial advisor before purchasing or selling a security.

The information and opinions provided herein are provided as general market commentary only, and do not consider the specific investment objectives, financial situation or particular needs of any one client. The information in this report is not intended to be used as the primary basis of investment decisions, and because of individual client objectives, should not be construed as advice designed to meet the particular investment needs of any investor.

The comments may not be relied upon as recommendations, investment advice or an indication of trading intent. PFG is not soliciting any action based on this document. Investors should consult with their financial adviser before making any investment decisions. There is no guarantee that any future event discussed herein will come to pass. The data used in this publication may have been obtained from a variety of sources including U.S. Federal Reserve, FactSet, Bloomberg, Bank of America Merrill Lynch, iShares, Vanguard and State Street, which we believe to be reliable, but PFG cannot be held responsible for the accuracy of data used herein. Any use of graphs, text or other material from this report by the recipient must acknowledge MarketDesk Research as the source. Past performance does not guarantee or indicate future results.   Investing   involves   risk,   including   the possible loss of principal and fluctuation of value. PFG disclaims responsibility for updating information. In addition, PFG disclaims responsibility for third-party content, including information accessed through hyperlinks.

No mention of a particular security, index, derivative or other instrument in the report constitutes a recommendation to buy, sell, or hold that or any other security, nor does it constitute an opinion on the suitability of any security, index, or derivative. The report is strictly an information publication and has been prepared without regard to the particular investments and circumstances of the recipient.

READERS   SHOULD   VERIFY   ALL   CLAIMS   AND   COMPLETE    THEIR    OWN RESEARCH AND CONSULT A REGISTERED FINANCIAL PROFESSIONAL BEFORE INVESTING IN ANY INVESTMENTS MENTIONED IN THE PUBLICATION. INVESTING IN SECURITIES AND DERIVATIVES IS SPECULATIVE AND CARRIES A HIGH DEGREE OF RISK, AND READERS MAY LOSE MONEY TRADING AND INVESTING IN SUCH INVESTMENTS. PFG Private Wealth Management, LLC is a registered investment advisor.

Providing Context on Recent Market Volatility

Monthly Market Summary

  • The S&P 500 Index returned -4.1% during August, underperforming the Russell 2000 Index (-2.0%) for a second consecutive month.
  • Energy (+2.7%) was the top-performing S&P 500 sector during August despite oil prices falling -9.7%. Utilities (+0.5%) was the only other sector to produce a positive return. Technology (-6.2%) was the worst performing sector as interest rates rose, followed closely by Health Care (-5.8%) and Real Estate (-5.6%).
  • Corporate investment grade bonds generated a -4.4% total return, slightly underperforming corporate high yield bonds’ -4.3% total return.
  • The MSCI EAFE Index of global developed market stocks returned -6.1% during August, underperforming the MSCI Emerging Market Index’s -1.3% return.

Stock & Bond Markets Endure a Bumpy August After July’s Gains

The S&P 500 produced a -4.1% return during August, but the headline number doesn’t tell the full story. Equity markets initially rallied during the first half of the month, with the S&P 500 gaining +4.2% through August 16th as July’s market rally continued. However, the second half of August marked a sharp reversal as the S&P 500’s gave back all its gains plus more. Credit markets also experienced a reversal during August as interest rates reversed higher and bonds produced negative returns. The increased volatility across stock and bond markets is being attributed to a wide range of investor views creating a tug of war effect in markets, as well as uncertainty regarding how long the Federal Reserve will continue to raise interest rates.

Federal Reserve Chair Pushes Back Against Hopes for Policy Pivot

The Federal Reserve held its annual August Jackson Hole meeting, and Chair Powell used his speech to forcefully push back against the notion the Fed will pivot and cut interest rates if economic data starts to weaken. Powell emphasized the central bank’s “overarching focus right now is to bring inflation back down to our 2 percent goal” and cautioned, “Reducing inflation is likely to require a sustained period of below-trend growth … [and] will also bring some pain to households and businesses.”

Investor hopes for a Fed pivot were one of the primary catalysts that propelled the stock market higher during July and August. Chair Powell’s speech dashed those hopes and sent the S&P 500 down more than -3% on the day of his speech. Why? Two lines from Chair Powell’s speech underscore the Fed’s goal, “There is clearly a job to do in moderating demand to better align with supply. We are committed to doing that job.” This focus on lowering demand for goods and services may increase portfolio volatility during the months ahead as investors debate how long it will take the Fed to achieve its goal and the impact tighter policy will have on the economy.

Important Notices & Disclaimer

The information and opinions expressed herein are solely those of PFG Private Wealth Management, LLC (PFG), are provided for informational purposes only and are not intended as recommendations to buy or sell a security, nor as an offer to buy or sell a security. Recipients of the information provided herein should consult with their financial advisor before purchasing or selling a security.

The information and opinions provided herein are provided as general market commentary only, and do not consider the specific investment objectives, financial situation or particular needs of any one client. The information in this report is not intended to be used as the primary basis of investment decisions, and because of individual client objectives, should not be construed as advice designed to meet the particular investment needs of any investor.

The comments may not be relied upon as recommendations, investment advice or an indication of trading intent. PFG is not soliciting any action based on this document. Investors should consult with their financial adviser before making any investment decisions. There is no guarantee that any future event discussed herein will come to pass. The data used in this publication may have been obtained from a variety of sources including U.S. Federal Reserve, FactSet, Bloomberg, Bank of America Merrill Lynch, iShares, Vanguard and State Street, which we believe to be reliable, but PFG cannot be held responsible for the accuracy of data used herein. Any use of graphs, text or other material from this report by the recipient must acknowledge MarketDesk Research as the source. Past performance does not guarantee or indicate future results.   Investing   involves   risk,   including   the possible loss of principal and fluctuation of value. PFG disclaims responsibility for updating information. In addition, PFG disclaims responsibility for third-party content, including information accessed through hyperlinks.

No mention of a particular security, index, derivative or other instrument in the report constitutes a recommendation to buy, sell, or hold that or any other security, nor does it constitute an opinion on the suitability of any security, index, or derivative. The report is strictly an information publication and has been prepared without regard to the particular investments and circumstances of the recipient.

READERS   SHOULD   VERIFY   ALL   CLAIMS   AND   COMPLETE    THEIR    OWN RESEARCH AND CONSULT A REGISTERED FINANCIAL PROFESSIONAL BEFORE INVESTING IN ANY INVESTMENTS MENTIONED IN THE PUBLICATION. INVESTING IN SECURITIES AND DERIVATIVES IS SPECULATIVE AND CARRIES A HIGH DEGREE OF RISK, AND READERS MAY LOSE MONEY TRADING AND INVESTING IN SUCH INVESTMENTS.

PFG Private Wealth Management, LLC is a registered investment advisor.

Looking Back at a Rocky First Half of 2022

Financial markets remained unsettled and volatile during the second quarter. The stock market’s trend changed multiple times as investors continued to search for direction amid a sea of changing conditions. The S&P 500 finished the second quarter with its worst three-month period since the first quarter of 2020 and worst first half of a calendar year since 1970. This quarter’s letter recaps the first half of 2022 and discusses the top investment themes heading into the second half of 2022.

2nd Quarter Sees a Mixture of Old & New Themes

Investors navigated a combination of old and new investment themes during the second quarter. Inflation pressures remained top of mind as the headline CPI accelerated at a more than +8% year-over-year pace during both April and May. In response to persistent inflation, the Federal Reserve continued to tighten monetary policy by raising interest rates at each of the April, May, and June meetings. Like the first quarter, stocks traded lower as the interest rate increases caused investors to dial back their risk taking.

Multiple new themes also emerged during the second quarter. Several retailers, including Walmart and Target, reported substantial inventory buildups as inflation pressured consumer spending on discretionary items. The retailers warned their profit margins could decline in the coming quarters as they may need to mark down items to clear the excess inventories. From a monetary policy perspective, the Fed supplemented its interest rate increases by starting to shrink its balance sheet. The Fed is opting not to reinvest the proceeds of up to $30 billion of maturing Treasury securities and up to $17.5 billion of maturing mortgage-backed securities per month. The decision is another way for the Fed to decrease the amount of money supply and liquidity.

Federal Reserve Gets Aggressive at June Meeting

The Federal Reserve adopted a more aggressive tightening stance at its mid-June meeting. The central bank raised the federal funds rate +0.75% and unveiled a ‘strong commitment’ to bring inflation back down to 2%. For historical context, June was the first +0.75% increase since 1994. The Fed’s latest moves are another indication of how 40-year high inflation readings are driving the Fed’s monetary policy decisions.

How does the current cycle compare to prior cycles? Figure 1 compares the current cycle’s federal funds rate path against the last five cycles. Factoring in the +0.75% increase at the June meeting, the Fed has raised interest rates +1.50% since the first increase in March. Investors expect the Fed to maintain its +0.75% pace at the late-July meeting, which would make 2022 the fastest +2.25% increase compared to the last five cycles. Market consensus calls for the Fed to keep raising interest rates at its meetings later this year, although the number and size of the increases remain open questions.

The June meeting represents a potential turning point. Why? Throughout the first half of 2022, investors were concerned the Fed was not being aggressive enough to combat persistent inflation pressures. The thinking was inflation could become entrenched if the Fed raised rates too slow, which could force the Fed to raise interest rates for a longer period and to a higher endpoint. The June meeting marks a clear change in the Fed’s thinking and indicates the central bank will front-load interest rate hikes if necessary to ease inflation pressures.

Investors initially reacted positively to the Fed’s updated guidance. The S&P 500 was down -19.1% from the start of the second quarter through the Fed’s meeting on June 16th. From June 16th through June 24th, the S&P 500 gained almost 6.7%, and Treasury yields declined. Why does this matter? The equity rally and declining Treasury yields suggest investors became slightly more confident the Fed’s aggressive tightening upfront could get inflation under control sooner. The quicker inflation is under control, the sooner the Fed may be able to slow its interest rate hikes and evaluate policy more rationally.

To be fair, there is a potential downside to the Fed’s new tightening approach, and the market appears to be focused on the risk as the second quarter ends. There isn’t a clear understanding of how fast or how much the Fed’s actions will impact the economy. There is a risk the impact from the Fed’s actions is delayed and the Fed keeps raising interest rates, potentially overtightening and slowing economic activity more than expected over the next 12-18 months. It’s a delicate balancing act for the Fed to pull off.

Economic Data Continues to Point to Softer Growth

The latest economic data indicates investors are justified in worrying about the Fed overtightening and tipping the U.S. economy into a recession. The stacked charts in Figure 2 track a range of economic indicators across housing, consumer confidence, the labor market, and consumer spending. The data remains strong relative to historical standards, but it does indicate the U.S. economy is starting to soften.

The top chart tracks the annualized pace of housing starts and building permits. Housing demand soared during the pandemic, but both starts and permits have declined more than -10% on an annualized basis since the end of 2021. The housing market slowdown coincides with a more than +2.50% increase in the 30-year fixed mortgage rate since the end of 2021, suggesting rising mortgage rates are already pressuring housing demand.

The second chart tracks month-over-month retail sales growth across multiple categories during May. It shows consumers spent more at gas stations and grocery stores as gasoline and food prices rose and less on discretionary-related goods, such as autos and auto parts, electronics and appliances, and home furnishings. The data offers a near-term look at how high inflation is impacting and shifting consumer spending.

The third chart tracks the University of Michigan’s Consumer Sentiment Index. The index made a new record low of 50 during June as consumer sentiment continued to deteriorate. Weaker consumer confidence coincides with high inflation and points to a worried U.S. consumer, which is concerning because the consumer accounts for nearly 70% of U.S. economic activity.

Source: MarketDesk, National Association of Realtors, U.S. Census Bureau, University of Michigan, Department of Labor.


The fourth chart tracks weekly initial jobless claims. While initial jobless claims remain low by historical standard, the trend has reversed from 2021’s steady decline as jobless claims drift higher during 2022. Separate data from the Bureau of Labor Statistics shows the U.S. continues to add new jobs each month, but the pace of those job gains has slowed significantly compared to 2021. The +390,000 jobs added during May 2022 were the slowest pace since April 2021. The two measures indicate labor demand is softening, a notable change from the last 12 months when businesses struggled to fill open jobs.

Equity Market Recap – Another Difficult Quarter

The second quarter was another difficult environment for equities. The S&P 500 Index lost -16.1%, only slightly outperforming the Russell 2000 Index’s -17.3% return. It was an especially difficult quarter for Growth stocks as rising interest rates continued to pressure valuations. The Russell 1000 Growth Index traded down -21.1% and underperformed the Russell 1000 Value Index’s -12.3% return. The Nasdaq 100 Index, which investors view as a concentrated Growth index due to its Tech overweight, traded down -22.5% during the second quarter.

U.S. sector returns offer another look at second quarter performance trends. Energy and defensive sectors, including Consumer Staples, Utilities, and Health Care, outperformed as investors rotated to commodities and risk off assets. Growth-style sectors, which include Consumer Discretionary, Communication Services, and Technology, underperformed the broad market as rising interest rates pressured Growth stocks. In the middle, cyclical sectors, including Materials, Industrials, and Financials, performed in line with the S&P 500.

International markets’ lower exposure to expensive Growth stocks allowed them to outperform U.S. markets during the second quarter. The MSCI EAFE Index of developed market stocks returned -13.1% during the quarter, while the MSCI EM Index of emerging market stocks returned -10.4%. Despite international stocks’ outperformance during the second quarter, questions remain about the impact of rising energy prices in Europe and tighter financial conditions in emerging markets (i.e., higher interest rates & lower liquidity).

Bond Market Recap – Rising Treasury Yields Lead to Additional Losses

Bonds traded lower during the second quarter as Treasury yields continued to rise in anticipation of tighter Fed policy. Corporate investment grade bonds produced a -8.4% total return, slightly outperforming the -9.4% total return generated by corporate high yield bonds. While investment grade bonds outperformed in aggregate during the second quarter, the group’s outperformance versus high yield bonds primarily occurred during the second half of June after the Fed’s new aggressive tightening stance caused investors to grow concerned about slower economic activity.

Figure 3 tracks the interest rate spread between corporate high yield bonds and Treasury bonds. The spread is a measure of credit risk, more specifically how much more yield investors demand in order to loan to riskier companies. The chart shows the spread widened significantly from 3.40% at the start of the second quarter to 5.26% on June 28th. The wider spread indicates investors are concerned about borrowers’ ability to make principal and interest payments as financial conditions tighten. Looking back at the past five years, the 5.26% spread is near levels last seen during late 2020, the months following the Covid outbreak, and late 2018, the last time the Fed raised interest rates.

Second Half 2022 Outlook – Unanswered Questions

The outlook is indecisive as financial markets close out a volatile first half of the year. Some investors believe the Fed’s actions will dramatically slow economic growth and push the U.S. economy into a recession. On the opposite end of the spectrum, some investors believe the U.S. economy is strong enough to withstand the Fed’s actions and view the stock market as oversold.
The back and forth is likely to continue until some of the market’s most pressing questions are answered. Key questions include the direction of Federal Reserve policy, inflation’s stickiness, the trajectory of corporate earnings growth and forward earnings estimates, and the path of economic growth. Our team will be monitoring the answers to these questions in coming months to help guide investment portfolio positioning.

The current investing environment requires a long-term outlook. Trend changes are frequent, fast, and driven by fluctuating market headlines, and keeping up with the day-to-day whims of the market can be emotionally taxing. Developing a financial plan and sticking to it are important steps to achieving your financial goals.

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