After a strong global rebound following the market downturn associated with the onset of the COVID-19 pandemic, both stock and bond markets have been incredibly volatile in 2022. In this blog post, we review the factors the have impacted stock and bond market performance in 2022 and consideration as we look forward over the balance of this year and the longer term.
Inflation, Interest Rates and War in Europe
Toward the tail end of 2021 and into 2022, we saw U.S. headline inflation readings (the Consumer Price Index or “CPI”) come in at annual rates consistently above 6%. The persistently high inflation rates with each passing month contradicted the Federal Reserve’s “high inflation is likely temporary” narrative, and as a result it became clear that the Federal Reserve would need to increase its short-term interest rate, which is often cited as the “federal funds rate.”
Because fixed income returns are generally negative when interest rates unexpectedly increase most fixed income investments have generated negative returns on a year-to-date basis. Further, because global stock markets tend to perform poorly during periods of unexpectedly high inflation, global stock markets have also experienced negative year-to date returns. On top of this, war broke out in Europe with the Russian invasion of Ukraine. This certainly exacerbated market uncertainty alongside food and energy price inflation.
During periods like the first half of the year, it is natural to be nervous about markets and question your financial plan, so we wanted to share points to keep in mind with a long term, forward-looking perspective in mind:
- The risk and return experience that most asset allocations have experienced so far in 2022 is within the downside risk that we plan for in our financial strategies and in thinking about allocation recommendation before an allocation is implemented.
- While inflation has been high, it is currently expected to moderate to more normal levels averaging around 3.0% per year over the next five years. This is elevated relative to what had been the norm but well below what inflation rates have been.
- While interest rates have increased substantially in 2022, it’s difficult to predict how interest rates will evolve from here. Markets are forward-looking, and one of the reasons rates have notable increased so far in 2022 is the expectation that the Federal Reserve will increase the federal funds rate significantly over the balance of 2022. In other words, interest rates, in general, have increased in advance of the Federal Reserve meaningfully increasing the federal funds rate.
- For investment portfolios that have stock allocations “tilted” toward small-cap and value-oriented holdings, those allocations have generally performed better than broad stock markets showing the value of diversification across different types of stock holdings.
Like we’ve experienced in 2022, there are always planning challenges and opportunities. As always, we’re here to help you navigate your financial journey. Feel free to reach out to us and discuss how we might help you.