2022 2nd Quarter Market Commentary

Top Headline for Q2: Worst “First Half” in 50 Years

It would be an understatement to say that it’s been a tough first half of the year. As measured by the S&P 500 Index, the U.S. stock market (down 20.6% year-to-date) is off to its worst start since 1970. Similarly, the bond market, as measured by the Bloomberg U.S. Aggregate Index (down 10.4% year to-date) is on track for its worst year since 1973. Normally, these investments are complimentary in investor portfolios (i.e., with one going up while the other is going down); however, the combined performance of these indices is among the worst in recent history. The industry standard “60/40 portfolio benchmark” comprised of 60% equities and 40% bonds is down 16.1% year-to-date. The next worst year in the last 50 was 2008 (which was down “only” 6.7%).  In other words, the first 6 months of this year is thus far nearly 2.5 times worse than the next worst “first half” in the last 50 years. 

As mentioned above, it’s been a rough year for both equities and fixed income. In the current market environment, it pays to be nimble. Shifts in bond duration and equity sector exposures will likely prove to have massive impacts on portfolios. While most Patina Wealth clients are down year-to-date, we are pleased with how client portfolios have performed relative to broad market indices. On the equity side of the portfolio, clients have benefited from an overweight of Value over Growth. Large Cap Value was -12.0% in the second quarter while Large Cap Growth was -22.4%. In addition, Patina Wealth’s “sector overlay”, where we allocate to specific sectors of the market we think will outperform the broader market provided a buffer to overall market declines. This strategy included having a Value overweight in sectors such as Financials, Energy, and Oil & Gas Exploration. On the fixed income side, portfolios were aided by having more exposure to short duration holdings which were less volatile during this rising rate environment. We are excited about continued opportunities to add value as we move forward in this volatile market. 

General Market Update

US Equities:  The pull back in equities accelerated in Q2. The S&P 500 Index fell 16.4% during the quarter, the Nasdaq Composite was down 22.4% and the Russell 2000 Index dropped 17.5%. These pullbacks were not unexpected given the equity market surge heading into the end of 2021 along with a highly anticipated “hawkish” Federal Reserve Bank (“Fed”) policy. Patina Wealth portfolios benefited from higher-than-average cash positions during the period coupled with more active rebalancing to take advantage of the increase in volatility. There were no “safe-haven” sectors found in Q2. However, the combination of client portfolios being overweight Value, in addition to our sector overlay, helped to avoid some of the equity market carnage seen in sectors such as Technology, Consumer Discretionary and Communications sectors, which are all down over 20% year-to-date.

International and Emerging Market Equities:  The Schwab International Equity ETF (SCHF), which holds stocks of developed markets excluding the United States, was down 13.6% in Q2 and the Schwab Emerging Markets ETF (SCHE) fell 8.3%. Having lagged the U.S. markets in recent history, international markets are now slightly outperforming US markets for the same reason (i.e., a lower allocation to high growth technology stocks which are now giving up some of the recent gains). Diversified exposure to these markets proved beneficial to client portfolios throughout the quarter.

Fixed Income and Credit: The bond market slide accelerated throughout Q2 with longer-dated bond indices down well over 20%. The Federal Reserve Bank policies of raising rates and beginning quantitative tapering, as we anticipated, proved to be massive headwinds for the bond market. Moreover, the increases in interest rates are now affecting the risk perception in the corporate bond market as we have begun to see “bond spreads” (i.e., the interest rate premium investors demand from corporate bonds relative to treasury bonds) expand sharply. Although all global bond categories slid during the period, Patina clients benefited from a substantial overweight to shorter-duration higher quality bonds during the period. 

Commodities, Precious Metals, Inflation: Inflation continues to be more persistent than most forecasters, including the Fed, predicted. The world has been working through inflationary impacts from unprecedented stimulus and now is faced with a general trend toward de-globalization and an ongoing war between Russia and Ukraine. Many commodities (including industry metals and lumber) have fallen from sky-high prices; however, supply constraints continue to cause major price spikes in the energy sector, especially in Europe, and experts see challenges for the food sector going forward (e.g., it has been reported that Russia and Ukraine produce over 25% of the world’s wheat). Precious metals have held up relatively well despite the “hawkish” narrative from the Fed which would normally send the market tumbling. 

A Look Ahead

As we look to the future, all eyes will be on central bankers, and, most notably, the Federal Reserve Bank of the U.S. The Fed has been extremely hawkish in action and commentary in the face of rising inflation. For example, the June rate hike was hinted by the Fed to be 50 basis points but was shifted to 75 basis points. With limited impacts showing up in reduced inflation thus far, the market is now predicting another 75-basis-point hike in July and possibly another in September. At this point, it seems clear to all that inflation is now the number one enemy of the state and the Fed. Thus, many concede that a recession may result from Fed actions. Experts seem to think that driving the economy into a recession is a necessary step to reign in inflation though the Fed is not likely to make such a statement.

At this point, the equity market has retreated to reasonable valuation levels as measured by “forward-looking” earnings projections. In other words, the price-to-earnings ratio for the S&P 500 Index, based on the next 12 months of projected earnings, is back down to mid teen levels. However, the concern going forward is the accuracy of the earnings projections. If a recession is imminent, there is typically a sizeable pull-back in corporate earnings so equity investors will be watching each announcement for signs of degradation. Moreover, inflationary pressures are not good for corporations as rising input costs and rising wages generally hurt margins. We would anticipate that the equity market will face continued pressure with the worst performance being felt by companies with limited cash flow and lower quality balance sheets (i.e., those least prepared to survive an economic downturn). Other companies, however, will emerge stronger as many cash-rich companies, including some large cap growth companies, are well-positioned for acquisition.

We’re likely entering an extremely volatile period for the bond market. Any acceleration in Fed policy tightening could send the market tumbling (especially higher risk categories such as “high yield” that perform poorly during recessions). However, any Fed actions or guidance that suggest a pause or reversal relative to current expectations may lead to a surge in bond prices and a rapid drop in yields. Staying nimble in the current environment will be important as the market will be hyper-sensitive to the Fed.

Please feel free to reach out during this heightened period of volatility. We are more than happy to walk through portfolio allocations and the rationale behind various positions. We’re excited to closely monitor market movements and capitalize on opportunities ahead.