May 2022 Individual Equity Portfolio Commentary
What a difference one quarter can make! If tax season wasn’t bad enough, we now have a category five hurricane roiling the markets. The five troublesome issues effecting stocks (and bonds) include:
- High inflation (not just in the U.S.)
- 2nd largest global economy (China) slowing due to lockdowns and policy uncertainly
- Land war in Europe (adding to inflation especially in commodities)
- Increased recession fears (especially Europe)
- Hawkish Fed and no more government stimulus
How did we get here? Because of the pandemic we recently had the fastest and deepest recession ever in 2Q 2020. That prompted coordinated monetary and fiscal policy which flooded the economy with money. The economy then dramatically rebounded (6 times faster than the prior economic cycle) and the Federal Reserve found themselves still pumping money into the system when it already had more than it needed. The Federal Reserve fell behind the curve and needed to painfully catch up, made much more difficult by the Ukraine-Russia war that stoked even higher inflation via supply shocks.
But it is not all gloom and doom. The US Economy is quite strong. Yes, we had a negative 1.4% GDP number in Q1 2022, but that was after a positive 6.9% number in Q4 2021. If we take the average of the two (about 2.7%), that could be a good proxy of the rate to expect moving forward (which would be a good thing). Also, the Federal Reserve, despite starting to yank the punch bowl away, may not have to raise rates as high as the market thinks, since there are some natural “brakes” now acting on the economy. One big brake are much higher mortgage rates which ultimately will cool the housing market. Another is the big and rising trade deficit (5% of demand of the US economy is going overseas!). Other good news is that U.S. households are in the best financial condition in modern history. Flush consumers are exploiting a robust jobs market and continue to spend at a breakneck pace.
Globally, China bears watching. The big question is if the China economy can re-accelerate after slowing because of the draconian lockdown policies. This is possible, especially since inflation is not an issue in China. We also need to see if Europe can avoid a recession, much of that unfortunately depending on how the war evolves (a bright spot is that the Eurozone just experienced its lowest unemployment rate on record).
Before we move on to discuss the equity market, it bears noting that we just experienced one of the worst bond markets in the last 50 years. Rarely have bond yields risen so high and so fast. There was nowhere to hide in the bond market – every fixed income sector experienced large price drops. The only silver lining here is that now bonds are somewhat more attractive, especially if inflation has already peaked.
US equities have already felt the pain of this hurricane. The S&P dropped approximately 15% YTD, but things were much worse for the NASDAQ and small cap stocks, which are down over 20% YTD. This does make stocks overall more reasonably priced, although most valuation metrics show that equity markets are still over-valued. In this volatile environment we think it is very important to be both well balanced and more defensively positioned.
As the May flowers bloom from the April showers, we look forward to having more detailed discussions about portfolio strategy with our clients.
Contact your Wealth Advisor if you have any questions or need further assistance.