Inflation remains the focus of both stock and bond investors. Price increases affect stock industries and bond types differently. Our focus remains on holding a diversified set of investments to mitigate the impact of inflation and achieve long-term growth targets.
1st Quarter 2022 Returns:
- S&P 500: -4.6% (measured by ticker SPY)
- International stocks: -6.2% (measured by ticker IXUS)
- Emerging stocks: -7.2% (measured by ticker IEMG)
- US bonds: -5.9% (measured by ticker AGG)
- US high yield bonds: -4.7% (measured by ticker HYG)
The earlier stock market correction (defined as fall by 10% from all-time high) is common, having occurred in 60% of calendar years since 1928. The subsequent rebound is also common, as we typically experience significant up days after pullbacks and selloffs.
We used this selloff as an opportunity to put additional cash to work for clients. As portfolios generate dividend and interest income, we are able to tactically deploy this cash into our model portfolios.
Both stocks and bonds fell for the same root cause: inflation. Inflation resulted in the bond market pricing in six to seven rate hikes from the Federal Reserve in 2022. Inflation also resulted in companies feeling pricing and labor cost pressure on bottom line results.
Investors are working to gauge how aggressive the Federal Reserve will be in raising interest rates. Steady quarter-point increases in each meeting send a different tone than half-point increases or even intermeeting rate increases. The later would signal that The Fed has increased concerns over inflation and its impact on consumers.
The chart below highlights the consensus for Fed interest rate increases over the next year.
What’s Next – Stocks
Whenever we talk about “the stock market”, we instantly think about the S&P 500. Interestingly, these 500 companies only represent roughly 10% of the total investable stock universe.
Through these additional companies, both US and internationally based, we can find attractive investments. We continue to invest in indices (i.e. groups or baskets) of quality, value and momentum stocks. We have a slight bias to value stocks over growth-oriented stocks, given current valuations. This bias has benefited our results in 1Q2022.
We also continue to find the mid- and small-cap segment of the market attractive. These companies are more domestic reliant for sales, meaning they benefit more from the strength in the US economy.
Although both stocks and bonds have fallen in 2022, it has been more than 50 years since both US stocks and bonds fell in the same year. Given a choice, we remain more constructive on the prospects for stock market total returns in 2022.
January and February bond returns marked the second worst start to the year. Bond prices fell as investors priced in quicker and larger interest rate increases by The Fed.
As noted above, the good news is that bonds have historically performed better after these poor starts. As interest rates rise, they present investors with higher interest income. As witnessed in 2021, the expectations for rate increases can be overemphasized to start the year and ultimately lessen.
Understanding that inflation is present for the immediate and intermediate future, we have positioned the bond portfolio to have increased credit exposure. Inflation provides a tailwind to companies issuing bonds. Through the first quarter of 2022, high yield bonds have outperformed US bonds by 1.2%.
This market’s volatility in both stocks and bonds offers a reminder of the importance in being diversified. Last year’s big winners in long dated bonds and technology companies are this year’s laggards. By remaining in diversified portfolios, we work towards achieving our client goals that extend well beyond the next trading day.