Quarterly Commentary

2Q 2022

Any way you look at it, investment returns so far this year are among the worst on record. Not since 1970 have stocks dropped 20% in the first six months. Foreign stocks haven’t done any better, in part because most currencies have lost significant ground to the US dollar. Bonds have offered little respite - it has been a sell-off for the ages.

Context is important, however. A decade of low inflation and even lower interest rates came to an end last December. US stocks and bonds posted annual returns of 16% and 3% amidst 2% inflation over those ten years – risk taking was highly rewarded. From just the start of 2019 to the end of 2021, the S&P 500 returned 100%!

While stocks climbed a wall of growing worries last year, by early 2022 the headwinds were too strong to sustain elevated valuations. The confluence of Chinese covid restrictions, Russia’s invasion of Ukraine and stimulus-driven inflation in the US overwhelmed markets.

Downturns are generally known for their primary causal factor: the 2000 dotcom bust, the 2008 Great Financial Crisis, and the 2020 pandemic collapse. The names imply that once prices have corrected or once “the problem” has been fixed, stocks will return toward their usual upward path, but as always, the exact moment stocks will start to look through to the other side is impossible to predict.


Today’s inflation is viewed as a consequence of massive government spending that boosted demand as covid shutdowns disrupted supply. That is true, yet reducing government outlays and increasing interest rates only addresses excess demand. There is little US policy makers can do to “fix” overseas or even domestic supply issues.

Inflation concerns were intensifying a year ago in the wake of the massive US relief and stimulus packages of 2020 and 2021. The transitory camp believed inflation would quickly subside once supply chains were straightened out. The persistent worriers noted that stickier factors such as rising housing costs could lead to entrenched inflation expectations that take many years to resolve. The distinction matters, but it may be that both were right – some drivers of higher prices have already reversed course while others are still surging.

Nearly all commodity prices peaked in early to mid-June and have fallen significantly over the last four weeks. This should help with fuel and food prices, among others, in the coming months. Expensive groceries and gas, combined with falling investment account balances, have led to all-time lows in consumer sentiment. The fact that this is happening while unemployment is near 4% and consumer and business balance sheets are in good shape, is unprecedented.

Six months into 2022, markets are still struggling to assess inflation’s future path and to assign probabilities to various outcomes. The uncertainty is magnified by geopolitical tensions that are particularly hard to anticipate. Covid responses in China (not to mention Chinese designs on Taiwan) and war in Ukraine may get worse and drive inflation even higher in the short-term but could also ease at any time and have deflationary impacts in the future. Put simply, there is a wide range of possible outcomes – too wide for the market’s taste at this point.

US recession on the way?

A recession in Europe, due primarily to astronomical energy prices and perhaps a gas shutoff this winter, is a foregone conclusion. But what about in the US? The Federal Reserve is an important actor – most prominent when a mistake has been made. After moving too slowly last year (easy to say now!), the Fed Governors are communicating that they will do what it takes to tighten financial conditions including higher borrowing costs for homebuyers and businesses, which they expect will slow the economy and reduce inflation. Recent CPI releases show inflation running at 9%, raising the possibility that the Fed will raise the fed funds rate by 1% at its July meeting. Many observers now expect that the US economy will enter a recession at some point this year as the Fed slams on the brakes.

A recession is defined as a minimum of two consecutive quarters of GDP contraction, and it is very possible that we’re headed in that direction. However, a contraction that only technically qualifies isn’t necessarily something to fear. Our economy is running at or beyond full employment, measures of business expectations are much less pessimistic than those of consumers, and both individuals and businesses are still benefiting from the stimulus (lots of cash) and low interest rates (refinanced debt) of the last two years. What has people feeling down has more to do with food and fuel inflation running ahead of wage gains and watching 401(k) accounts tumble.


This is an unpleasant stage of the economic cycle that we have not experienced in decades but if we are approaching the nadir, it could be a lot worse. Global famine or nuclear actions would be crises - we can only hope they remain tail risks.

The Fed is on its way to establishing its inflation-fighting credibility and will hopefully know when it’s time to stand down. Inflation break-evens, a measure of future expectations that compares the yields of Treasury Inflation Protected Securities to regular Treasury Bonds over periods of five to ten years, are now lower than they were a year ago. Bonds have had a tough start in 2022, but if investors thought there was a real risk of rampant inflation (like the 1970’s), Treasuries would be priced very differently.

A correction of this nature sees share prices move from optimistic to more realistic approximations of value, and can overshoot, creating undervaluation. Will markets snap back quickly, as in 2020, or might a recovery take several years, as was the case in 2000 and in 2008? We believe many stocks are now priced for a shallow recession and much of the exuberance from 2021 has been washed out. We’re hopeful that we’re in the later innings and whenever the bottom is “in,” there should be sharp rallies along the way – opportunities for the patient.

Other than the previously mentioned geopolitical wild cards, perhaps the most concerning aspect of the current situation for stock investors is the absence of the “Fed put”. Between the end of the Great Financial Crisis and the emergence of covid, investors assumed that anytime conditions deteriorated, the Fed would support markets with lower rates and/or quantitative easing. With the current focus on taming inflation, that safety net is no longer evident.

While we intensely dislike seeing account values drop, this is a healthy and natural market reset that is leading to better investing opportunities and providing an education to those who may have been careless with their investing. In the long run, the entire economy loses when good money chases after unproductive assets. 

As noted above, we are doing our best to understand the risks facing both the economy and markets and are focused on effectively navigating this most challenging environment. Your patience and understanding bolsters our efforts to invest for one or two year returns while the markets are all over the place, reacting to the latest economic data or piece of news.