Spring 2022 Commentary

April 11, 2022

Following 2021, which delivered impressive gains and calm markets, 2022 has been turbulent and mostly negative. The market was very volatile in the first quarter and losses have been widespread. The market began the year with a decline of ‐5.2% for the S&P 500 in January. In February, the index fell another ‐3%. Losses continued in the first half of March, but the market then reversed and posted a strong rally to finish the month with a 3.7% gain. In all, the S&P 500 lost –4.6% in the first quarter, and at its worst, was down as much as –12.5%.

S&P 500

Dec 2019 – Mar 2022

*This graph is not intended to recommend any investment or investment activity.

The negative shift in the market began in early January, when Federal Reserve Chairman Jerome Powell gave a speech indicating the Fed’s intention for a significant monetary policy shift to fight off the rising threat of inflation. Their plan involves reducing the size of their balance sheet and raising interest rates. This abrupt shift in policy caused both the stock and bond markets to turn negative.

Then in February, Russian President Vladimir Putin commanded his military to invade Ukraine. This surprising attack added even more downward pressure to the market. The positive lift in the market in late‐March came only as the Fed somewhat softened its hawkish tone in their March policy meeting and Russian forces appeared to stall in their advances on Ukrainian territories.

The Covid crisis, which has entered its third year, caused many unexpected consequences and disruptions. There have been multiple waves of infections with varied responses from policy makers around the globe. Here in the U.S., we appear to be entering a new phase where we are learning to live with the threat of the disease, and day‐to‐day activities are quickly returning to pre‐pandemic norms.

However, that has not been the case in many parts of the world. China, for instance, took a very different approach by shutting down cities and enforcing strict lockdowns every time an outbreak occurred. This continues and has been highly disruptive to the global manufacturing eco‐system. An acute bottleneck has occurred in the manufacture of computer microchips, essential to the production of many finished products, automobiles in particular. Ongoing supply constraints in microchips have led to limited supplies of finished autos, and all at a time when the global economy is recovering and demand is increasing.

Lower supplies and increasing demand naturally has led to rising inflation. Beginning in earnest in the middle of last year, inflation in the U.S. and around the globe has been running much hotter than has been experienced in decades. The hope was that the supply disruptions would quickly subside and that inflation would cool. Unfortunately, this has not been the case. In the latest reading, the Consumer Price Index (CPI) was measured at 7.9%, the highest reading in 41 years, and well above the roughly 2% per year we’ve experienced over the past decade. Additionally, Russia is a major exporter of oil and gas. Severe sanctions handed down to Russia by western countries as punishment for their military aggressions have severely limited the flow of Russian energy exports, which has added to inflationary pressures.

Here in the U.S., the consequence of higher consumer prices has been the need for intervention by the Fed to take action in an attempt to calm rising inflation. Their plan is to decrease the size of their balance sheet by unwinding their bond buying program and increasing interest rates in an effort to dampen economic activity. The real and perceived effects of the Fed’s actions have caused bond yields to spike. The benchmark 10‐year U.S. Treasury bond yield rose to 2.4% at the end of the quarter after beginning the year at 1.5%. This has caused Barclay’s Aggregate Bond Index to fall 5.9%, which is the worst quarterly performance for the index since 1980. This means that during the quarter’s stock market selloff, bonds failed to fulfill their customary role of playing defense in client portfolios.

Another significant effect in the bond market has been the recent inversion of the yield curve. A yield curve inversion occurs when short‐term bond yields are higher than long‐term bond yields. This can often portend an economic recession, indicating increased anxiety among investors about near‐term economic conditions. However, the circumstances of the yield curve inversion are abnormal in this case. It has not been caused by economic difficulties in the traditional sense. This inversions has been primarily caused by the recent monetary policy actions by the Fed. Therefore, many strategists feel that this inversion may not be as meaningful as in the past. It is also worth noting that as of this writing, the yield curve has steepened and is no longer inverted.

One of the most acute effects of rising interest rates has been in the mortgage market. In just 6 months, the interest rate on a conventional 30‐year fixed rate mortgage has jumped from 3.0% to 4.7%. This has a significant impact on the cost to own a home. For example, the monthly payment on a $250,000 mortgage has risen from $1,054 to $1,297, representing a 23% increase. If higher mortgage rates persist or move higher, there’s a strong possibility of a cooling of the red‐hot housing market, which saw home prices jump by an average of 16.9% last year.

30-Year Fixed Rate Mortgage

*This graph is not intended to recommend any investment or investment activity.

In the equity market, the economic cross currents resulted in a sudden shift in market leadership. For several years, growth oriented companies, tech companies in particular, have greatly outperformed slower growing value companies. So far this year, it has been the opposite. The Russell 1000 Value Index outperformed the Russell 1000 Growth Index by 8.3% in the first quarter after trailing the growth index for the past five years.

Aside from the apparent negatives in the market and economy, there is positive news to report. U.S. GDP has surpassed pre‐pandemic levels and is expected to grow by over 6% this year. Corporate profits are expected to grow 8%. Unemployment has fallen to 3.6%, which ties the pre‐pandemic low and represents the lowest level in over 50 years. There are signs that supply disruptions are beginning to resolve which should help to cool inflationary pressures. In short, the U.S. economy is currently in very good shape. The long‐awaited postpandemic liftoff appears to be underway, despite the troubles we’ve outlined above. For now, we expect the volatility to continue in the near‐term. Like every crisis, we expect things to eventually calm. When they do, the market should find its footing and begin moving again in a positive direction.

Thank you very much for your continued confidence in our service and advice. If you would like to discuss our opinions, outlook, or your portfolio in greater detail, we would be happy to schedule a meeting or a conference call at your convenience. Lastly, don’t keep us a secret. If you know someone who would like help planning for their financial future, we will be pleased to speak with them to see if we can assist.

Owen Murray, CFA

Owen Murray joined Horizon Advisors in 2005. As a core member of the wealth management team, Owen is principally involved in investment research and portfolio construction.