It has been a violent start to 2022 marked by volatility, war in Europe, and economic uncertainty. While the US appears to be largely insulated from much of the Russia/Ukraine economic headwinds, the impact of higher energy prices is weighing on economic growth and compounding inflationary pressures, just as the Fed embarks on a rate hike regime. The ultimate spillover effects from the Russian/Ukrainian war remain to be seen (especially as it relates to globalization), but in the US we still see indications of economic strength and opportunities for risk-assets (i.e. equities) to perform.
Exhibit 1:
Equity Market (S&P 500) and Fixed Income (BBg Agg) Performance in 1Q22
KEY POINTS
War, inflation and politics threaten to derail global growth
- Russia’s invasion of Ukraine has upended the world order, capital markets, and may be the start of a downward trend for globalization and centralization of monetary banks.
- The equity market sell-off in 1Q (especially technology stocks) started over inflationary concerns and was amplified by the Russia/Ukraine conflict, but partially recovered by quarter end; volatility is likely to persist.
- The Fed hiked rates in 1Q (first time since 2018) to tame inflation but is fighting an uphill battle as labor markets remain tight and spillover from Russia/Ukraine is just starting.
- Rising oil costs, supply chain disruptions from the Russia/Ukraine war, and the start of a Fed tightening cycle are significant headwinds to ongoing economic growth.
- Portfolio diversification and hedging are increasingly difficult given correlated movements in fixed income and equities (Fixed income experienced its worst performance in decades). Real assets and less liquid investments can help.
Exhibit 2:
Key Markets Performance in 1Q22
International communities, markets, and economies were rocked by Russia’s invasion of Ukraine and the proceeding war. The war remains ongoing, but some of the spillover effects are already occurring. Globalization and decentralization, key ideas that drove companies and countries to expand operations around the world post World War 2, are facing their greatest challenges in a century. Global supply networks, especially around natural resources, have been shuttered and will need to be reoriented in the coming years. Energy prices are at their highest levels since the early-2000s, inflation is soaring globally, and at the same time most central banks are attempting to scale back policy support. All of which is to say that global growth will be challenged to maintain its post-COVID pace.
Exhibit 3:
Consumer Spending vs. Personal Savings
But despite the negative headline news we remain optimistic on the outlook for 2022, especially in the US. The strength of the current labor market is uncontested, consumers continue to spend, credit spreads have fallen (and remain well below historical levels) and equity markets, despite all the volatility, have bounced off their lows and are holding.
The US appears largely insulated from the economic spillover from Russia/Ukraine, with energy prices being the key spillover risk. This will be important to watch going forward, especially as the Fed attempts its delicate balancing act of aggressive rate hikes to combat inflation without hurting the economy. In addition any signs of weakness in corporate earnings (especially margins) and consumer spending would be red flags.
Net-net we expect volatility will remain elevated in 2Q and suggest investors sit back and (where appropriate) strategically add risk to portfolios and continue to allocate more into short duration fixed income.
ENDNOTES
Disclosures
This commentary reflects the personal opinions, viewpoints and analyses of the author providing such comments, and should not be regarded as a description of advisory services provided by Defiant Capital Group or performance returns of any Defiant Capital Group client. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Defiant Capital Group manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary.
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A word on risk
All investments carry a certain degree of risk, including possible loss of principal, and there is no assurance that an investment will provide positive performance over any period of time. Equity investments are subject to market risk or the risk that stocks will decline in response to such factors as adverse company news or industry developments or a general economic decline. Debt or fixed income securities are subject to market risk, credit risk, interest rate risk, call risk, tax risk, political and economic risk, and income risk. As interest rates rise, bond prices fall. Non-U.S. investments involve risks such as currency fluctuation, political and economic instability, lack of liquidity and differing legal and accounting standards. These risks are magnified in emerging markets. This report should not be regarded by the recipients as a substitute for the exercise of their own judgment. It is important to review your investment objectives, risk tolerance and liquidity needs before choosing an investment style or manager.