Q2 2022- Market Commentary
Investment markets began a new chapter at the start of 2022, with the Federal Reserve signalling that it was going to take decisive action to tackle inflation head on, as inflationary pressures pushed even higher in Q2 due to the conflict in Ukraine and the second order effect of higher commodity prices across the board.
As a result of market movements in Q2, global equities officially moved into a bear market, with the S&P 500 falling 21% from the beginning of January to June. The pain wasn’t only felt in equities, with fixed interest investments suffering and experiencing their worst start to the year since records began in 1990, despite being seen as a hedge against riskier assets.
Looking at the first 6 months in further detail, the first leg lower in markets was driven by a duration crash, whereby anything long duration (Technology, Sustainability, Small Cap stocks) was derated and we now believe we’ve gone into the second stage which relates to concerns around a recession. Markets are facing the challenging prospect of going into a period when interest rates are rising at a time when the global economy is showing signs of slowing down.
What happens next depends on whether we go into a recession or not. If central banks continue to struggle in their efforts in keeping down inflation and have to raise rates during a slowing economy, this could trigger a ‘hard landing’ which would likely result in further volatility in markets.
In terms of the winners and losers in Q2, whilst value stocks outperformed their growth counterparts for the second quarter in a row, both saw sharp falls by 9.5% and 18.5% respectively. Large cap companies held up relatively well as traditionally defensive areas of the market outperformed, including the Telecommunications, Healthcare and Consumer Staples sectors, whilst Energy maintained its strong start to 2022 as the oil price moved higher. In contrast, small and mid-cap stocks were negatively impacted by a deteriorating consumer backdrop together with interest rate expectations moving higher over the period. Asia, and in particular China, was one of the standout markets as Covid-19 lockdown measures started to be relaxed, whilst investor sentiment towards the country was also boosted after government data showed that factory activity grew in June.
Moving forward, we do think now is a time to maintain balance within portfolios and we continue to adopt a patient approach. As Benjamin Graham famously once said, “in the short run, the market is like a voting machine, but in the long run, it is a weighing machine”. Markets in the short term are dictated by short term trends and fashions, whereas in the long term, fundamental factors such as the quality of the business drive investment returns. Our role is to look beyond the short-term noise and assess what the world will likely look like 12-18 months from now; will inflation still be prevalent? Will there be a recession? Will the conflict in Ukraine have ended? Will Covid still be prevalent in Asia impacting supply chains? This is where we spend our time and until we get a degree of clarity on these points, we are of the view that diversification is vital.