MARKET RETURNS:  Global equities closed out a volatile first quarter of 2022 with mid-single digit declines, partially retracing 2021’s strong upward move despite recovering a bit from their intra-quarter trough.  U.S. large company stocks remained the top performing category, proving more resilient against a turbulent market backdrop compared to other areas of the world.  However, returns for smaller U.S. companies were comparable to international stocks despite dollar appreciation.  Developed markets fared slightly better than emerging within that international group as Russia and its neighbors were more directly and severely impacted than Western Europe by the economic fallout from its invasion of Ukraine, while other commodity exporters tended to benefit from rising prices.  High quality bond prices also fell by nearly 6%, pricing a faster pace of interest rate hikes than previously anticipated.  That sharp decline does however come with a silver lining in the form of higher coupon payments from bond holdings.  We’d also expect higher cash yields following the Federal Reserve’s first policy rate increase since the onset of the Covid pandemic, yet associated returns remained paltry during the first quarter.

LOOKING FORWARD: 

2021 Was the Anomaly, not 2022:  Investors in equities should expect volatility, as easy as that fact is to forget after a year like 2021.  Investment risk and return tend to go hand-in-hand, so those wanting to participate in stock market appreciation should be prepared for a few bumps along the way.  The average intra-year drawdown for large U.S. stocks has been -14% going back to 1980, as shown in the chart below.  We’re almost exactly on that average so far this year at -13%, while the corresponding number for 2021 was only -5%.  Yet domestic large caps have finished in positive territory most years despite those interim declines, providing cause for optimism that they may ultimately do the same in 2022.  This dynamic can be viewed as part of the more normalized investment environment we had anticipated for this year, though we acknowledge that very real risks in the form of armed conflict, an inflation overshoot and/or a hawkish Fed policy mistake now appear more probable than at the outset.  The bond market is a different story: it’s difficult to envision high-quality bond prices fully recovering from their Q1 selloff this year, rendering rare back-to-back annual declines the likely outcome.  Higher rates however mean that bonds may reclaim their “fixed income” moniker sooner than expected.

Getting Real about the Energy Transition:   Recent events have served as a reality check on ambitions for a near-term shift to renewable energy sources, though the longer-term direction of travel continues toward renewables for both environmental and strategic reasons.  Germany serves as an interesting case study, as its push to phase out coal and nuclear in favor of wind and solar left it overly reliant on Russian gas.  The map below shows both the concentration of fossil fuels in locations with controversial leadership as well as relatively low reserve levels in the U.S.  The severe cold wave brought by Winter Storm Uri last February highlighted the fragility of the fragmented electrical grid structure in this country and served as a powerful example of the vulnerability of renewable generation to extreme weather.  Both this event and the German example underscore the importance of maintaining redundancies during a transition and making unbiased assessments of potential energy sources.  Whether evaluating policy or investments, the full range of related social and governance considerations should be contemplated in addition to the direct and indirect environmental effects.  We remain conscious of the myriad trade-offs involved as we seek to position portfolios in the context of a cleaner energy future.

Conclusion:  Despite a volatile first quarter, there are many reasons to be constructive on the potential for future investment performance.  The underlying economy remains robust and nowhere is that more evident than in the red-hot U.S. labor market.  With fundamentals intact and stock prices lower, valuations have become more attractive and potential buyers abound, as seen in both money market fund balances and corporate buyback activity.  Sentiment has rebounded to neutral territory after falling to the most fearful levels seen since the onset of the COVID-19 pandemic.  At the same time, potential risks have become elevated.  Inflation remains high and a 1970s style wage-price spiral could result if it becomes embedded in psychology.  Policy is more constrained as the Fed tries to fight inflation while avoiding recession and further fiscal stimulus seems unlikely in the face of political gridlock, though that circumstance may help tame inflationary pressures.  Geopolitical conflict is of course no longer a tail risk and additional setbacks related to the pandemic are always possible.  We’re preparing our reallocation “shopping list” should these risk factors dominate and traditional assets reach more attractive levels.

Index Descriptions:

S&P 500 Index TR is a market capitalization weighted index which represents the broad market for large company U.S. stocks.  Returns reflect the reinvestment of dividends.

The MSCI EAFE Index NR USD is a market capitalization weighted index which represents the broad market for large and mid-sized developed market stocks excluding those from the U.S. and Canada.  Returns reflect the reinvestment of dividends and foreign withholding taxes and are translated into U.S. Dollars.

The MSCI EM Index NR USD is a market capitalization weighted index which represents the broad market for large and mid-sized developing market stocks.  Returns reflect the reinvestment of dividends and foreign withholding taxes and are translated into U.S. Dollars.

The Bloomberg Barclays U.S. Agg Bond Index is a market capitalization weighted index which represents the broad market for taxable investment grade U.S. dollar-denominated bonds. Returns reflect the reinvestment of interest. 

The US Treasury Bill Auction Avg 1-month is an index comprised of short-term U.S. government-issued investments with yields collected weekly and can be considered a proxy for cash.

Portfolio performance, characteristics, and volatility may differ from the benchmarks shown. Opes portfolios are managed according to their respective strategies which may differ significantly in terms of security holdings, industry weightings, and asset allocation from those of the benchmarks. Benchmarks are unmanaged and provided to represent the investment environment in existence during the time periods shown. An index is not available for direct investment, and does not reflect advisory fees, any of the costs associated with buying and selling individual securities, or any other fees, expenses, or charges. Past performance may not be indicative of future results. 

The opinions expressed in this article are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security. All opinions expressed herein constitute the judgment of the author(s) as of the date of the report and are subject to change without notice. The material has been gathered from sources believed to be reliable, however Opes cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. This information may contain certain statements that may be deemed forward looking. Please note that any such statements are not guarantees of any future performance, and actual results or developments may differ materially from those discussed.  Opes does not provide tax or legal advice, and nothing contained in these materials should be taken as such. As always please remember investing involves risk and possible loss of principal capital. Advisory services are only offered to clients or prospective clients where Opes and its representatives are properly licensed or exempt from licensure. No advice may be rendered by Opes unless a client service agreement is in place.