Review of The First Half of 2022 and Our Outlook Looking Forward
July 15, 2022
Moving into the third quarter, we wanted to provide an update on the first half of 2022 and our outlook looking forward for the rest of 2022.
Summary of the first half of 2022
It was a challenging start to 2022 as a combination of rising interest rates, economic headwinds and exogenous shocks have caused stocks and bonds to fall in tandem for the first time this century.
The first half of 2022 has been the most difficult start for the stock market since 1970 (the stock market is down ~20%) and the worst start for the bond market since the late 18th century according to Deutsche bank (low risk bonds are down ~10%). Cash is also losing value at a meaningful rate, with inflation as measured by June’s CPI print coming in at 9.1%.
We have moved from a low interest rate environment into a rising interest rate environment. Russia’s ruthless invasion of Ukraine has caused disruptions to energy markets and higher commodity prices. Ongoing Chinese lockdowns continue to disrupt global supply chains and impact the global economy (China’s GDP today came in at 0.4% for the second quarter, below consensus estimates).
Economic indicators have started to slow down for the most part as manufacturing PMI’s, retail sales, housing starts and more are coming in below consensus expectations.
On the other hand, unemployment remains close to all-time lows at 3.6% and spending on services in the economy (a large portion of US GDP) remains firmly in expansion territory as measured by service PMI’s.
Looking forward
As we’ve mentioned previously, JP Morgan CEO Jamie Dimon is an industry thought leader we pay close attention to. In JP Morgan’s second quarter earnings report released yesterday, Dimon mentioned that while the job market and consumer spending remain healthy, high inflation combined with geopolitical threats and quantitative tightening could have negative consequences on the global economy in the not-too-distant future.
On the positive side, the S&P500 has actually rallied 2% since Wednesday’s CPI print of 9.1%, despite that number being higher than expected. The stock market is forward looking and is down ~20% year to date, which means that news implying a future slowdown in economic activity is already at least partially priced in to stocks. That said, we expect the market to remain relatively volatile for the rest of 2022 and have taken a number of defensive actions in the portfolio over the second quarter.
Portfolio positioning update
At the asset allocation level, we took protective measures in the portfolio through our investments in hedged notes that are designed to reduce risk.
We funded this by reducing our allocation to international equities after Russia’s invasion of Ukraine (which we think will continue to cause economic and company level disruptions in Europe in the near term).
We increased our allocation to structured yield notes with what we view as attractive terms.
We increased our allocation to quality high dividend companies with defensive characteristics and durable financial positions.
We reduced our exposure to cyclical companies as economic indicators slow and increased our allocation to companies in defensive sectors like healthcare and consumer staples that are well positioned to grow earnings through economic uncertainty.
We are focusing on what we own, why we own it and valuations opposed to trying to time when we should enter or exit the market
These actions are detailed further in our quarterly presentation, which will be distributed next week.
*Different investors have unique circumstances, and the application of these portfolio positioning changes is tailored around your financial situation. For select investors, some of the above portfolio positioning may not be applicable in some scenarios.
We are staying the course and staying invested
While navigating bear markets can be mentally and emotionally challenging, the best course of action in this environment is to own a high quality, diversified portfolio with a tilt towards defensive positioning. Attempting to time the market usually results in realized losses and missed gains and cash is now losing value at a rate of 9% per year.
As a result and as always, we remain invested in high quality companies and we have also introduced hedges to part of our equity portfolio over the quarter to manage near term volatility. Stocks and bonds have historically rebounded rapidly in the years following a bear market, with the average bull market lasting two and a half times longer than the average bear market and returning 162% on average since 1926.
Bull and bear markets through history
Source: JP Morgan Asset Management
Disclaimer
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