Market Update — July 2022
Investment Committee Meeting Highlights
May’s Consumer Price Index (CPI) reversed April’s softening, showing prices rose 8.6% over the prior year, versus 8.3% in April and 8.5% in March. The acceleration in prices prompted the Fed to react more aggressively, hiking rates by 75 basis points when expectations just a few weeks prior were solidly on a 50-basis point hike. The more aggressive action by the Fed quickly reset expectations for the remainder of the year and, in doing so, inserted a fresh bout of volatility across capital markets. Over the month, the S&P 500 fell by 8.26% and the Bloomberg US Aggregate fell by 1.57%.
Globally equity markets largely moved together with the MSCI EAFE falling 9.28% and the MSCI Emerging Markets Index falling 6.65%. Under the hood of the US market, mid cap was the relative underperformer, but when we’re talking high single-digit losses for the month, that’s not saying much. However, consumer staples and health care did outperform the S&P 500 by nearly 600 basis points, losing 2.50% and 2.66% respectively.
The US yield curve rose in reaction to inflation and the Fed, with the short end of the curve rising faster than other sections. Despite the short-end moving up, there is not an inversion at critical points of the yield curve, despite the 10-year yield is now below the 5- and 7-year yields. Rising yields always spell price reductions in bond markets, prompting a sea of red across all major bond categories, with short duration (1-3 year) and agencies relatively outperforming.
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The S&P 500 Index fell considerably in June which ended the worst first half of a year since 1962. History warned us that 2022 would be a challenging year, but we didn’t know just how far prices would fall because of soaring inflation, a new rate tightening cycle, a Russian invasion of Ukraine, an ongoing supply chain disruption, and a possible recession. There is hope, with company earnings coming out later in July, that this will help combat recessionary pressures and improve the current state of the economy.
Volatility has seemed to have found a new normal, which is higher than what it was prior to March of 2020. Credit spreads continued to widen over the course of June, effectively saying there may be more risk in corporate balance sheets than before. Markets continue to quickly react to changing expectations around the Fed, inflation, and the economic environment. Together, this paints a difficult environment for the market to price in expected volatility.
While the bond market is known for being characteristically slower, and sleepier, credit spreads, and yields in general, have been volatile lately. Credit spreads indicate how risky the market believes lower-grade bonds are, the higher the spread, the more yield the market demands to be compensated for that risk. Since the start of the year, the spread between yields of high yield corporate bonds and 10-year US Treasuries has significantly increased, largely from movements in the yield curve as well as economic softening.
Implied equity volatility has remained elevated since the start of the pandemic, though it has been punctuated by even higher spikes during periods of expectation adjustment and uncertainty. The length of time it has remained elevated has slowly, but surely, substantially increased the three-year average. Typically, volatility shocks, such as the one at the early 2018, quickly revert to more normal levels of implied volatility. However, after the fall from pandemic highs, there have only been periods of relatively slow declines in implied volatility.
The New York Fed publishes a Global Supply Chain Pressure Index, which has been showing at least some level of improvement over the last few months, though overall supply chains continue to remain stressed. Backlogs at major ports have started to clear up, as well as shipping costs coming down. However, the length and breadth of the lockdowns in China and the overall size of supply chain-related issues still have plenty of room to improve. The costs to ship goods have come down off their highs in late 2021, though remain well above long-term averages and have a long way to go to reach their pre-pandemic levels.
As we continue to grasp the new norm, and prepare for what could be instore, we emphasis that we are continuing to follow the data and use a quantitative investing approach. Your portfolios are recalculated bi-weekly ensuring that we are in the best to achieve your individual financial goals.
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