There is no way to sugarcoat the first half of the year—it has been ugly. As of 6-30-22 the stock market is down roughly 20 percent and the bond market is down approximately 10 percent. Historically, bonds have offered a cushion from stock market declines, but 2022 has been an outlier. As we look forward, valuations now look more attractive in stocks and bonds. We believe the worst is behind us but expect volatility to remain elevated.
Rising interest rates, inflation, and geopolitical pressure have created a rollercoaster ride YTD. We believe FED rate hikes have largely been priced into the bond market. Therefore, we expect pricing pressure to ease going forward for bonds. Rising rates have caused many long-duration assets like growth stocks to sell off dramatically. The S&P Growth index was down -25% relative to the S&P value index, which was down -11% in the first half of the year. Growth stocks consist of companies like Apple, Amazon, and Google. In contrast, value stocks include companies like Johnson & Johnson, Procter & Gamble, and Exxon. All are great companies, but given the extreme repricing of growth companies, we think there are attractive opportunities in profitable growth companies.
Inflation is the biggest concern for investors today. Recent inflation numbers have been extremely high. While we believe inflation will moderate throughout the rest of the year and into 2023, it is likely to be stickier than initially anticipated, particularly in areas like wage inflation. Inflation started in physical goods demand during Covid and today has shifted to services demand. Geopolitical pressure related to Russia and Ukraine has added to inflation pressure by increasing existing supply chain issues and contributing to soaring energy prices. All this to say, we need inflation to get under control for the markets to march higher.
If inflation doesn’t moderate in the coming months, the Federal Reserve will likely push the economy into recession. While it is not our base case, it is a possibility we must be aware of. The correction we have seen YTD is the market anticipating the likelihood of a recession. The market is a leading indicator, meaning stock prices will adjust based on future expectations. On the other hand, the market often will rally long before the economy recovers, as we saw during Covid. The good news is that consumers and corporate balance sheets are in great shape to weather a recessionary environment. No one wants a recession, but if we were to have one, the current backdrop is ideal.
Inside client accounts, we have implemented several changes to dampen volatility. We have added commodities, reduced equity exposure in favor of short-term bonds, and added hedged equity positions. These changes are designed to ease volatility and keep investors invested. As we all experienced during the 2020 Covid market correction, markets can fall and rebound rapidly. One of the worst things investors can do is move to the sideline and miss market rallies off the bottom. We are constantly looking for attractive investment opportunities to deliver the best outcomes for our clients and feel confident we can achieve this moving forward.