Quarterly Commentary

1Q 2022

The first quarter of 2022 for investors can be viewed in three parts: Valuations Normalizing (Jan. 1 to Feb. 23), War Breaks Out (Feb. 24 to Mar. 8), and Stocks Rebound (Mar. 9 to Mar. 31).  Below you’ll find a summary of these periods, followed by some thoughts about the remainder of 2022, acknowledging that the range of possible outcomes seems especially wide this year.

We would be remiss if we didn’t first recognize the tragedy unfolding in Ukraine as each day brings more news of suffering and struggle. In addition to the immense human toll in Ukraine, much of the rest of the world is dealing with significantly higher food and energy prices, with the greatest impact felt by those least able to able to afford it.

Valuations Normalizing

The first seven weeks of 2022 saw markets grasping to return toward “normal” as Covid cases in the United States peaked in early January and dropped rapidly to pre-Omicron levels by late February. The Fed had everyone’s attention as it signaled its intention to fight inflation by raising interest rates and curtailing bond purchases. US stocks and bonds were both falling, arguably to valuations more consistent with reality and reflecting concerns about diminishing fiscal and monetary stimulus. By February 23rd, the S&P 500 had declined more than 10% from its January 4th high, while the small-cap Russell 2000 and the tech-heavy Nasdaq 100 had fallen more than 20% from highs reached last November.

War Breaks Out

The relative calm with which markets were adjusting before February 24th ended with Russia’s invasion of Ukraine. European stocks quickly fell 12%, extending what had been a modest decline to a 20% drop from their highs of November 2021. US stocks fared much better, falling just 1% over the first two weeks of the war. Spreads between treasuries and riskier bonds widened, raising the cost of borrowing for companies, especially smaller businesses and those with shakier balance sheets. With broad-based inflation measures showing year-over-year increases near 8%, and equity and bond markets showing signs of stress, “normal” sure felt a long way off.

This left the Fed in a particularly tight spot. Its job is to keep the economy humming and keep a lid on inflation. The Fed’s response to recent crises (9-11, housing collapse, pandemic) has been to cut interest rates – and that doesn’t work when inflation is the crisis.

Stocks Rebound

As is often the case, markets found a bottom when investors were most anxious. The last few weeks of March saw a furious rally of 8% (US) and 12% (Europe) that narrowed losses for the quarter to about 5% in the US and 7% in Europe. It was a bad quarter for stocks, but not nearly as bad as it could have been.

The bond market continued falling, completing its worst quarter in fifty years. Anticipating that the Fed will raise short-term rates aggressively, yields on two and three-year bonds rose about 1.5%, while the yield on the ten-year treasury rose about 1.0% - leaving all three yielding about 2.5%. The quarter ended with much discussion about the flat or slightly inverted yield curve, often interpreted as a harbinger of a recession (though prone to false signals).  


The Fed is expected to raise overnight interest rates to 3.0% in the next twelve months. Will that be sufficient to tamp down inflation without triggering a recession? The optimistic view is that inflation expectations are not entrenched as they were in the 1970’s. As the war cools down, the pandemic eases and jobs are filled, inventories will quickly be replenished, and price competition will return, perhaps mitigating the need for the Fed to be aggressive. The pessimists argue that higher prices are already forcing consumers to cut back on spending and that even higher prices are on the way. The grimmest forecast is several years of stagflation – inflation and unemployment both running higher than 5.0%.

There is an old saying that bull markets don’t die of old age. It takes something more than the passage of time to turn an advancing market into a challenging one. The causal factors are not identified until after the fact, of course. Past culprits include things like geopolitical shocks (such as the oil embargoes of the 1970’s), a major policy error from the Federal Reserve, or the bursting of a bubble (tech stocks in 2000). Each can lead to inflation, a recession, or both.

It appears that we have two out of three, at least for now. And most US and foreign stock indexes have already recorded the 20% decline that qualifies as a bear market! The average stock is now about 30% below its 52-week high.

It is fair to say that our deeply held long-term optimism is being tested by the Ukraine conflict. We assume that democratic capitalism and a continuation of global trade will ultimately persevere, albeit with some amount of manufacturing shifting back to the US and Europe. At the moment, it seems all parties are ignoring some written or unwritten agreements that have facilitated cooperation and trade since the end of the Cold War. Russia and China are clearly unhappy with the status quo – a world order built around (and some argue held up by) America and the US Dollar. Hopefully the situation in Ukraine will stabilize quickly, lessening the unimaginable burden on their people, but this will certainly not be the end of the larger contest.

What does this mean for markets? Barring a spillover of armed conflict into NATO territory, markets may have largely recalibrated for the consequences of the Ukraine conflict, as callous as that may sound. Also of great concern to today’s markets are China’s fierce lockdowns in what seems to be a losing battle for “zero covid”. Supply chains for electronics, car parts and many other goods are once again being thrown into disarray. Experience has taught us this will pass; however, China’s strategy is likely to further inflame inflation and depress growth for months to come.

While our base case is muddling through it all, resolution won’t be apparent for many months – patience and perspective are critical. Investors are wary and many anticipate a weaker economy and turbulent markets. Keep in mind that US consumers are still in excellent financial shape, unemployment is extremely low, and many people are eager to get out and enjoy the experiences they missed over the last two years. Markets are forward-looking – bond prices now reflect the Fed’s likely response to inflation and stocks are well along in the adjusting process.