The volatility that started in the first quarter, intensified into the second quarter, leaving both stocks and bonds with their worst first half of the year since 1970. In the second quarter, domestic large-cap stocks fell by -16.1%, domestic small-cap stocks declined by -17.2%, international stocks were down by -14.3%, and domestic bonds dropped by -4.7%. When you combine the first and second-quarter results, this left most stock indices down more than 20% and bond indices down by more than 10% for the year.1
There were a variety of factors that contributed to these challenging results but none more so than inflation. In June, headline inflation increased by 0.3% to 8.5%, which is the highest level since December of 1981, while core inflation decreased by 0.1% to 6.0%. (See below for the difference between headline and core inflation and a chart referencing the underlying components). Due to the higher-than-expected reading on headline inflation and lower-than-expected decrease in core inflation, the Federal Reserve increased the fed funds rate by 0.75% at their June meeting, which is on top of the 0.50% they increased rates at their May meeting. Chairman Jerome Powell and the other Federal Reserve members also continued their narrative, reiterating their primary focus of slowing inflation.
Given all the focus on inflation, this strengthened the other major factor for the pullback this quarter which was the fear of a recession within the next year. We acknowledge that this can be a worrying topic for clients, but it is important to understand that recessions come in all shapes and sizes (aka duration and severity). Should we see a recession, our expectation is that it is short and shallow due to the strong labor market, resilient consumer spending, and positive earnings growth by many companies. Even if we are incorrect in our expectation, the median stock market decline for a recession since 1948 is -24% while the max decline in 2022 has been -25% for the S&P 500. Typically, the median return for the S&P 500 is +39% one year from the trough and +58% two years later. See the chart below for details2
We know these are unsettling times, but we expect the current volatile environment to persist for the coming months, especially with additional interest rate increases anticipated from the Federal Reserve, the Russia/Ukraine conflict persisting, and the mid-term elections in November. We know there have been a lot of negative headlines circulating but it is more important in volatile times like this to remain focused on your long-term goals.
As always, we appreciate your trust and confidence in all of us at MSA Financial. Should you have any questions or if you would like to schedule a time to review your portfolio or discuss the economic environment, do not hesitate to contact us.
Headline Inflation vs Core Inflation
There are two major inflation measures that are frequently mentioned when discussing inflation. The first of those inflation measures is headline inflation which is a reading from a basket of goods and services to determine how prices have increased over a given time period. The second is core inflation which takes a reading from the same basket except it eliminates any goods and services from the food and energy sector (given the volatility of those sectors) to get a more balanced reading.
1Market segment (index representation) as follows: Domestic Large Company Stocks (S&P 500), Domestic Small Company Stocks (Russell 2000) International Stocks (MSCI EAFE), Domestic Bonds (Bloomberg Barclays US Aggregate Bond Index), Growth Stocks (MSCI World Growth) and Value Stocks (MSCI World Value)
2What history says happens to stocks if there’s a recession - https://finance.yahoo.com/news/history-stocks-recession-102913314.html
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