Top Headline for Q1: Nowhere to Hide

In our end-of-year update, we warned of a likely pull-back in 2022, and it certainly arrived. US and global equity indices fell considerably with the technology sector faring the worst as expectations for interest-rate increases intensified. Nasdaq indices even reached “bear market” territory (i.e., a decline of 20%+) before surging to close the quarter. Declines were broad-based with 9 of the 11 S&P 500 Index sectors closing down for the quarter. Despite rallying late in March, Growth (VUG) ended the quarter down 10.3% while Value (SCHV) was down 2.1%. The bond market story was arguably worse; long-dated bond indices fell double-digits, a quarterly slide that the Wall Street Journal reports as the worst in the last forty years. Bond holders seem to have finally capitulated to the fact that rates are headed up and sold off with a fury. To make matters worse, we ended the quarter with an ominous economic sign (i.e.., an “inverted yield-curve”). Inverted yield-curves generally forecast economic recessions which we’ll cover in more detail below in “A Look Ahead.”     

General Market Update

US Equities:  The expected and perhaps needed pull back in equities finally arrived. The S&P 500 Index fell 4.9% during the quarter, the Nasdaq Composite was down 9.1% and the Russell 2000 Index dropped 7.8%. These pullbacks were expected given the equity market surge heading into the end of 2021 that occurred despite the prospect of rising interest rates, rising wage inflation and continued global supply chain disruptions. Most sectors fell but the Utilities sector (e.g., XLU), which serves as a classic “safe-haven” investment, was up slightly. The outlier was the Energy sector (e.g., XLE was up nearly 40%(!!)), which was buoyed by both an overall shift to value stocks along with massive supply shocks caused by the Russian invasion of Ukraine.      

International and Emerging Market Equities:  The Schwab International Equity ETF (SCHF), which holds stocks of developed markets excluding the United States, was down 5.5% in Q1, and the Schwab Emerging Markets ETF (SCHE) fell 6.2%. International markets have greatly lagged the US markets in recent history. Given that these equities have a greater tilt toward value and a heavier allocation to sectors that benefit from rising rates/rising inflation, these markets present an interesting potential opportunity ahead.    

Fixed Income and Credit: We’ve been beating the drum about bond risk for a long time now. It took longer than we expected to materialize, but the headwinds (i.e., Federal Reserve tapering, planned rate increases and inflation concerns) finally became too overwhelming. The 10-year US Treasury surged from 1.512% at the start of the quarter up to 2.327% by quarter-end. All duration bonds in both corporate and sovereign debt fell hard with long-duration corporates (e.g., VCLT) and sovereigns (e.g., VGLT) dropping over 10%. Fortunately, for Patina Wealth clients, we had an overweight on shorter duration positions (VCSH), which greatly mitigated the impact, as shorter duration bonds have much less overall price volatility. 

Commodities, Precious Metals, Inflation: The COVID driven impact on global supply chains continues to be a significant contributor to pockets of inflation. Industrial metals have seen substantial price spikes, and now, with the Russian invasion, energy prices are also spiking. Sadly, we’re also seeing price spikes in food sectors – a problem likely to worsen given the importance of Ukraine to the global food supply chain (e.g., Russia and Ukraine produce over 25% of the world’s wheat). Precious metals may finally be starting to break out to the upside as inflation fears intensity (e.g., Gold, as measured by the ETF GLD, was up 5.7% during the quarter.)

A Look Ahead

In the current market it certainly pays to be nimble. Patina Wealth clients have generally benefited from an overweight to value equity and short-duration bonds heading into 2022. Moreover, our tactical sector overlays, which included exposure to some of the better performing equity sectors in Q1 (e.g., Materials, Energy and Financials), also added value to client portfolios. Moreover, we were more active in shifting exposures during the quarter as rebalancing opportunities emerged. 

The inverted yield-curve certainly makes us all nervous as we assess our portfolios. Risk assets generally perform worse during economic cycle downturns as consumer spending drops and the appetite for lending falls (i.e., liquidity tightens for companies of all sizes). It’s important to note that (1) an inverted yield-curve does not portend an immediate recession and (2) market impacts vary wildly from recession to recession. As we look forward, we anticipate continued volatility in 2022 driven mainly from Federal Reserve Bank actions, inactions and verbal commentary. Interest rate changes have massive impacts on bond markets and certain equity segments (e.g., technology). So, in a year where we are predicted to see rates rise by 150-200 basis points, large impacts will unavoidably be felt. Moreover, any material shift by the Federal Reserve Bank (actual or perceived) will likely cause substantial swings in risk assets. 

The bond market will be particularly interesting to watch as the over-arching trends in the US are deflationary (e.g., tech-innovation, an aging population, and high levels of indebtedness) suggesting downward pressure on rates and yet rates are spiking. It would not be surprising, in fact, it would be expected based on historical precedent for the market to overestimate rate increases leading to an eventual “oversold” bond market, thus a buying opportunity. On the equity front, we could see some rough earnings reports ahead as inflation (i.e., both higher wages and higher production inputs) do some damage to corporate income statements. However, any sudden reversal from current rate-increase expectations would likely be a tailwind to equities which could override any negative earnings news. As always, we will seek to stay nimble and will actively rebalance portfolios in hopes of capitalizing on any volatility in the markets.