In this latest installment of our quarterly newsletter, we share our observations on the second quarter of 2022 and our outlook for the remainder of the year. Click here to go to the full report on our website. Following are the highlights:
- The second quarter of 2022 saw a continuation of the negative momentum that began in the first quarter. Rising inflation and interest rates, as well as slowing growth in the U.S. and abroad caused sharp retreats in both the stock and bond markets.
- The S&P 500 index posted a negative total return of 16.5% in the second quarter, putting it in bear market territory for the year with a negative return of 20.0%. The tech-heavy NASDAQ fared even worse, down 22.4% for the quarter and down 29.5% year-to-date. This marks the worst first half of the year for equity markets in nearly fifty years.
- The bond market, as measured by the Barclay’s Aggregate Bond Index, also posted negative returns, falling 4.7% in the quarter and 10.3% for the year, as rising interest rates caused bond prices to fall at a rate that exceeded their interest payments.
- A major contributor to market volatility has been the sharp rise in inflation in the U.S. this year. In June, the Consumer Price Index, or CPI, the primary measure of inflation, soared 9.1%, an unexpected increase from the 8.6% rate in May. It was led by sharp increases in energy prices (up 42%) and food prices (up 10%) and is the highest level of inflation since November 1981.
- This will likely prompt the Federal Reserve to continue its aggressive interest rate tightening by raising the fed funds rate another three-quarters to one percent this month, on top of the three-quarters percent increase in June, which was the largest monthly increase in short-term interest rates since 1994.
- Despite the numbers, it can be argued that we may be at or near a peak in inflation. Energy prices, which contributed roughly half of the June increase, have declined substantially since then, with crude oil prices dipping below $100 per barrel in July, the first time since early May.
- In addition, the core inflation index, which strips out volatile food and fuel prices, slowed slightly to 5.9% in June from 6.0% in May and 6.2% in April.
- If all of this is sustained, we believe it could bring down overall inflation in the coming months and reduce pressure on the Fed, allowing it to slow future rate increases.
- The economic debate has shifted from whether the economy will slow this year to when – and for how long – it could move into recession. A recession is generally defined as two consecutive quarters of negative GDP growth.
- U.S. GDP shrank at an annual rate of 1.6% in the first quarter, the first contraction since the onset of the pandemic in early 2020. Estimates for the second quarter GDP range from negative 1% to positive 3% growth.
- While we would rather not see a recession, the silver lining in a recession scenario is that an earlier recession means an earlier recovery. In other words, the sooner a recession arrives, the sooner inflation pressures will ease, and the less the Fed will have to tighten.
- Consensus estimates for 2022 corporate earnings have so far remained little changed, forecasting better than 10% earnings growth for this year, despite the fact that 70% of the companies that have issued guidance for the second quarter have trimmed their earnings estimates. We will be watching carefully how this earnings season unfolds and would not be surprised to see a downward revision in consensus estimates for full year 2022 earnings.
- Given this backdrop, our near-term outlook is for the market to remain volatile into the second half of the year. Continuing uncertainty around inflation, interest rates, and the geopolitical risks in China and Ukraine are likely to keep investors jittery.
- But longer term, our outlook remains optimistic. Pillars of strength in the U.S. economy include continuing low unemployment, positive, albeit slowing, annual GDP growth, and strong corporate and consumer balance sheets.
- Our investment approach remains unchanged: don’t panic; don’t sell good investments at depressed prices; and maintain a long-term, disciplined approach to investing in high quality companies that can withstand market downturns.
- We also continue to take an active approach to individual security selection and remain committed to our long-term, value-oriented investment philosophy.
- Overall, it is a challenging time for all investments, but we remain committed to selecting equity and income securities with the potential for attractive, long-term positive returns over full market cycles.
The Edgemoor Team
