Q1 in Review

2022 has gotten off to a rough start. Stocks began to buckle under the prospect of the Fed’s response to runaway inflation even before Russian forces invaded Ukraine. Putin’s decision to invade Ukraine not only exacerbated the prospects for lasting inflation, but also the prospect for a continually destabilized geo-political world. Before the markets staged a comeback the last half of March, the Nasdaq 100 and the Russell 2000 were each down over 20%, while the S&P 500 was down over 10%. The final tally for the quarter for U.S. stocks was modestly better, with the S&P finishing down 4.6%, the Russell 2000 down 7.54%, and the Nasdaq 100 down 8.76%. This past quarter was the first negative quarter for stocks since Q1 2020.

Stocks were not the only asset class to get off to a bad start. Barclay’s Aggregate Bond ETF was down 5.85%, while the 10-year US Treasury bond price declined by over 6%. On the other side of the ledger, DBC, Invesco’s Commodity ETF, was up over 25%, and gold was up over 5%. The massive rally in commodities followed Russia’s invasion of Ukraine. The sanctions placed on Russia caused a substantial rally in oil and oil products, as well as metals such as nickel. Ukraine is a large producer of wheat and the prospect for a production disruption sent wheat prices skyrocketing.

None of these moves in commodities helped dispel the prospect for large increases in interest rates for the coming year. Over the past three months the market’s expectations for Fed rate increases has risen from 5 to 9 hikes. With the Fed desperately in need of playing catch up to bring down inflation it looks increasingly likely that we may see near-term rates move from near zero at the start of the year to somewhere near 2.5-3% by year’s end. With inflation hovering near 8% it seems necessary for the Fed to start moving rates up at a quicker pace than ¼ percent at a time. Moves in the expectation of short-term rates has caused the yield curve to invert. Notably this means that the rate on 2-year notes is higher than the rate on 10-year notes. Yield curve inversion tends to predict future recessions. Prospects for recession are not generally positive for risk assets like stocks.

Unfortunately for anyone trying to time the market, yield curve inversion doesn’t offer much in the way of a good timing mechanism. The last time the curve inverted was August 2019. The S&P 500 continued to climb another 18% afterwards and was only sent lower by the outbreak of Covid. The yield curve also inverted in 2006 and the market continued climbing for another year and a half before finally succumbing to recessionary pressures.

Early parts of rate hiking cycles also do not necessarily portend bad news for the stock market. Rather the market seems to struggle mid-to-late cycle. However, one thing that makes this time a bit more unique is the degree to which the Fed is behind pace. I tend to be in the camp which views this cycle as more fraught with danger because of the projected velocity of rate hikes which will push the whole cycle into fast forward. The next quarter may provide more answers to the questions posed in the first.

Thanks for reading,

Zach and Dave

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