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After a very solid year for equity markets in 2021, stocks stumbled out the gate in 2022, producing negative results for most major indices for the quarter. After dealing with the pandemic for most of the last two years, it appeared we were turning a corner on COVID, at least here in the United States, and then a new challenge emerged when, on February 24, Russia invaded Ukraine.
As a human tragedy was unfolding with significant loss of life and millions forced from their homes, markets and economies had yet another new challenge to face. Many equity investors rushed to the sidelines until greater certainty could be achieved, leading to increased volatility and the first market correction (decline of more than 10%) for the S&P 500 since March 2020.
Impacts of the Russia-Ukraine Situation
Most of the developed world united and issued sanctions to punish Russia economically for their actions. While these sanctions caused significant financial stress on the Russian economy, markets and currency, the rest of the world felt reverberations as well. While Russia’s share of global GDP is only about 3%, they are a significant exporter of natural gas, oil, minerals and agricultural products.
Disruption in the energy markets as a result of sanctions led to a surge in the price of oil and many other commodities. Prior to the invasion, inflation was running at levels not experienced in almost 40 years. The recent surge in energy prices further exacerbated existing inflation problems, reducing consumer purchasing power and in turn threatened to derail economic growth here in the U.S. and abroad.
The Federal Reserve Begins the Inflation Fight
Bonds are generally considered a safe haven during times of market stress, but this quarter was clearly an exception. Surging broad-based inflation, tight labor markets, nagging supply chain bottlenecks and increasingly aggressive Federal Reserve rate hike expectations combined to drive the sharpest quarterly decline in U.S. Treasury returns since the U.S. Treasury index inception in 1973. The broad-based investment grade Bloomberg U.S. Aggregate Bond Index declined -5.9% for the quarter, marking the second worst quarter since the index’s inception in 1976.
Tough policy guidance by Federal Reserve policymakers amid soaring inflation played the major role in the quarter’s rise in interest rates. The Fed spent the first two months of the quarter completing the wind down of its pandemic related quantitative easing (QE) program and then in March the Fed policy committee voted to raise overnight rates by 0.25% as expected. Fed Chairman Jay Powell’s pointedly hawkish rhetoric in his March post meeting commentary caught investors by surprise as he stated rate hikes are on the table at each of the remaining six meetings of 2022. Powell assured listeners the U.S. economy is solid and can handle higher rates. Again the fixed income markets heard Chairman Powell’s message and traded rates sharply higher in response.
It’s very interesting, though, that in the weeks following the Fed’s launch of an expected string of Fed Funds rate increases, U.S. Equity markets rallied sharply, suggesting markets are encouraged by the Fed’s determination to address its inflation challenge in a deliberate and aggressive manner.
Where do we go from here?
The backdrop is a difficult one as the Fed tries to reverse many of its extraordinary pandemic related policies and move back to a more neutral position while navigating a ‘soft landing’ for the economy. While 1Q22 is likely to be a downbeat correction to the overly robust 4Q21, likely in a 1.5-2.0% Q/Q AR, we continue to expect 2022 as a whole to exhibit solid growth around 3.0%, as the U.S. economy inevitably slows toward long-term norms.
Read our comprehensive Q1 report for additional highlights of the quarter, and gain details and insights from the Hancock Whitney Asset Management team about these and other noteworthy events. And, as always, we're ready to help you reach your financial goals.
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