Market Update: It's Always the Unknowns
Well, this past quarter was not in the 2022 roadmap! In last quarter’s market update, I outlined three potential market villains for the year:
1. A Covid Return
3. Rising Interest Rates
Little did I know, a real world Bond Villain (Putin) would be the catalyst for most of the market's headwinds this year. Frankly, that is the way these things go: THE UNKNOWN IS ALWAYS THE PROBLEM. The market and its participants were just as aware of the three headline risks I assessed and, therefore, those risks were already priced into the market.
In my view, at the beginning of the year, the prospect of Russia invading Ukraine was not fully priced in and is the main reason for the market selloff in late January and February. Alas, the world and by extension the market has seemed to recover from the initial shock of this invasion and has recovered some.
The S&P 500 finished the quarter down 4.60% but is well off the lows of March (-12.36%). If we look closer at market segments I think there are two even more interesting stories unfolding. The first is the contrast between Value and Growth stocks. As you can see below Growth stocks have been decimated this year while Value is holding quite well in large, medium, and small stocks.
Last quarter I wrote that if the Fed begins to raise interest rates to combat inflation that would create a difficult environment for Growth stocks and potentially an ideal situation for Value stocks (I also said it would be really tough on bonds more on that in a minute). This has played out clearly but to be fair I believe it has been exaggerated by the war in Ukraine. The war has pushed up commodity prices which a good share of the stocks in the value sector are correlated with.
Although stocks have been beaten up this year, bonds I think are the real story. Bonds usually act as a bellwether when stocks experience volatility and serve as an anchor to calm the storm of portfolio fluctuations. This investing “rule” becomes a problem when confronted with another investing “rule”... “When interest rates rise bonds go down”. That is the exact conundrum (bondnundrum?) we find ourselves in. Stocks are down but we cannot rely on bonds as an offset due to rising interest rates. This is where short duration bonds and gold come into play.
- Despite the headwinds in the broad bond market (-5.85% in Q1) short term higher yield bonds and gold have done comparatively well.
Looking forward we believe that for the market to finish with large total gains the war in Ukraine needs to be resolved and the Fed must walk a careful line. The war in Ukraine is of course an unpredictable situation and the outcome should not be speculated on by financial advisors. That being said I believe that now that the initial shock of the invasion has worn off the market will be treating this situation with less knee jerk reaction and more careful analysis which will not result in indiscriminate selling (absent some major and tragic escalation).
The Fed’s war against inflation however is one that I believe will continue to provide knee jerk selling and buying well into 2023. I came up with an analogy to describe the Fed’s situation that I had our skilled marketing director Haley turn into a cartoon. Jerome Powell (The Fed Chair) is attempting to walk a tightrope from a low interest rate environment to a normal interest rate environment and if he stumbles on that tight rope he will fall into the fiery pit of a recession. Meanwhile, Vladimir Putin is shooting him with a nerf gun to knock him off balance.
In all seriousness, the Fed has a tough job. They have to combat rampant inflation by raising interest rates to slow growth during a global geopolitical crisis without causing a recession. This is known as a soft landing and is very difficult to execute. With that said the consumer is strong enough to endure some slowing in the economy and the job and housing markets are getting to the point where they are too strong. I believe the Fed can pull this off but I do not believe we will see double digit market growth this year. The market can certainly go up significantly from where it is right now, but expectations should be tempered when compared to the double digit growth of 2019, 2020, and 2021.
This commentary on this website reflects the personal opinions, viewpoints, and analyses of the Financial Strategies Group, Inc employees providing such comments, and should not be regarded as a description of advisory services provided by Financial Strategies Group, Inc or performance returns of any Financial Strategies Group, Inc Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data, or any recommendation that any particular security, portfolio of securities, transaction, or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Financial Strategies Group, Inc manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.
Written by Brice Carter