Investor Insights: First Half Recap and Current Market Conditions

Submitted by: First Bank Wealth Management’s Chief Investment Officer

While various financial market returns are down double-digits and many are in correction territory, undoubtedly, the first half of 2022 has been nerve-racking for most investors. We started the year with unprecedented, soaring inflation at rates that have not been seen since the late 70’s and early 80’s, as well as higher food and energy prices, supply chain disruptions, the Omicron variant, and to top it off, news of Russia invading Ukraine!

Ironically, most of these events were not surprises and have been developing for some time. The first half of 2022 will go down in history as the third worst first half of the year for the S&P 500 since 1950. Fixed income investors were not immune either. As the Federal Reserve started to increase rates, bond prices fell. During times of normalcy in the market, equity and fixed income have a low correlation to each other and fixed income tend to offset equity volatility.  However, during these times of high uncertainty, coupled with a rising interest rate environment, these two asset classes tend to move in tandem.

The recovery from the 2020 COVID Pandemic was phenomenal combined with very accommodative Monetary and Fiscal policies, a strong labor market with historically low unemployment, healthy wage growth, and solid 2021 market returns for various domestic and international markets. However, stretched asset valuation, increasing inflation, and the Fed’s intention to raise rates and reduce their balance sheet were among the main reasons for the financial market to start feeling the uncertainty and react accordingly. Markets tend to dislike uncertainties, especially the ones that could not be easily priced in.     

Although consumer spending was strong during the first quarter of 2022, the Gross Domestic Product (GDP) contracted by the 1.6% annual rate mainly due to trade deficits as exports fell while imports soared. A stronger U.S. Dollar did not help either. It was clear the U.S. economy has started to experience a slower growth. Financial markets trade on future earnings/growth expectation and, although a slower growth is not the same as no growth, just the expectation of a lower revision for future growth will cause markets to exaggerate the declines.

Clearly, the Fed was behind the curve when they recognized the need to curb inflation. That said, Powell’s Fed is faced with tough choices to make; either continue to aggressively tighten in hopes to control the soaring inflation (now measured at 9.1% as of June CPI) in the short term but risk driving the economy into a recession, or alternatively, let this inflation run for several years which would erode purchasing power and consumer personal savings.

We fully understand all of these conflicting forces are adding to the justified fear all investors are facing. However, it is important to remember that these events are typical and major characteristics of investing. The fact that for most of the past 12 years, we have been experiencing bull equity markets with high, double-digit annual returns (with some exceptions) has intensified the feel of investors’ anxiety, as investors tend to have short-term memories, especially for bear markets. Moreover, even with the most recent, shortest bear market in history (lasting only four weeks) during the 2020 pandemic, investors started to see recovery the following month in April 2022. The fact of the matter is, corrections and bear markets are very normal and a part of a typical economic cycle.

The reality is that investing is always worrisome and risky, especially in hard times like we are experiencing. If it weren't, it would be really unwise to invest, because there would be no risk premium, and there would be no opportunity to make money above the risk-free rate you would earn in a typical money market account. Historically, risk-free rates always lagged real rates (factoring in inflation rate) and lost purchasing power overtime. So, volatility is always going to be associated with investing, regardless of the venue you choose to invest in, including stocks, bonds, or even real estate assets.

Since 1921, the U.S. economy’s average length of expansions was 47 months verses an average length of recession of only 14 months. This demonstrates we have an economy of long summers and short winters. The key is to be diversified, stay invested, and trust the process. Our economy is built with what seems to be a “self-healing” mechanism and even if we are going into a recession, led by a policy mistake (Fed tightening too hard, too quickly), I believe it will be a mild one. Also, if the economy enters into a recession, it is expected that the Fed will tap the brakes on rate hikes or even reverse its course and start cutting back rates.

Natural events, such as storms and hurricanes, occur quite often, more often in some parts of the world than other, and people learn to adapt to and live with these events, recognizing that as mild or sometime violent events are taking place, either way they are short-lived.

Your portfolio is constructed based on long-term market risk/return expectations and your assets are allocated based on your risk tolerance you discussed with your portfolio manager. The diversification provided through the various asset class, market capitalization and styles you own, should help your portfolio to weather the storm. The best aid you could lend to your portfolio is to be patient. We recognize it is easier said than done, but remember the long-term perspective of your investments.

It’s vital for the success of your investment strategy to avoid making long-term costly, and sometime irreversible, mistakes derived from the urge to react to short-term market turmoil.

At First Bank Wealth Management, we continue to monitor and rebalance your portfolio to avoid additional, unnecessary risks while taking advantage of market dislocation through periodic rebalancing.

Finally, for investors who are either sitting on the sideline trying to pinpoint the market bottom to start investing or adding to their investments, I say this is going to be impossible or, if it happened, it would be by sheer luck. In fact, once all of the fear and uncertainties are gone and settled down, the market would have already moved and settled up, costing investors prime entry time for investment opportunities. Recall that the surprising, rapid, and most recent recovery started in April 2020 in the midst of the COVID Pandemic.

In conclusion, with the year-to-date market decline across different assets, a nice portion of the current uncertainly has already been priced into the market. Nevertheless, the risk of a recession is increasing, presenting the possibility for deeper market declines. We may experience a recession in late 2022, if the Fed maintains its aggressive rate hike policy. However, the recession could also be delayed to 2023, as the U.S. economy loses steam and further slow growth continues its downward momentum over the next few months.

Regardless of when a recession might occur, we maintain our long-term view and confidence in the resiliency of the U.S. economy. We remain positive, despite years of high uncertainty and market volatility, where we know with a high-level of certainty that diversified and patient investors will reap the rewards of market recovery and the growth of a newly-born bull market cycle.

Get an objective portfolio review from a First Bank Wealth Management trusted advisor.

Rest assured, you are not alone during these turbulent times and we are available to address any of your concerns. Please feel free to reach out to your Portfolio Manager or the trusted team at First Bank Wealth Management.

By: George Nicola CFP®, CIMA®, CAIA Senior Vice President, Chief Investment Officer		As the Senior Vice President, Chief Investment Officer, George is responsible for leading and supervising the Portfolio Management Team as well as directing the investment process for First Bank Wealth Management. With 20 years of experience in the industry and a deep knowledge of financial markets and wealth management, George is also responsible for managing a bespoke group of private and institutional clients’ portfolios providing thought leadership, insight, and goals-based consulting services, through a disciplined investment process. You may contact George Nicola at (949) 475-6304 or via email at [email protected].