The first six months of 2022 proved to be very challenging for equity and fixed income investors alike around the world. The U.S. stock markets experienced their worst performance since the early 1970s, with the S&P 500 down over 20%, the Nasdaq Composite dropping 29.5% and the Russell 2000 index of smaller U.S. companies producing a negative return of 23.9%. It was the worst first half on record for the Nasdaq and Russell 2000. Unfortunately, investors could not find any reprieve in the fixed income market either as a wide index of U.S. fixed income securities, the Bloomberg U.S. Aggregate, was down 10.7%. The last time it saw such a big drop was during the 1970s, which also was a period of high inflation.
These negative financial developments are happening sadly in the context of a brutal war in Europe not experienced since World War II. Besides the tragic human suffering, the war in Ukraine is contributing to a sharp increase in the energy prices, with crude oil jumping more than 40%. In addition, many agricultural commodities are showing sizable price increases. Consequently, the inflation rate in the U.S. as measured by the Consumer Price Index reached 8.6% in the 12-month period ending in May – the largest yearly increase since December 1981 during the Iran-Iraq war. The Federal Reserve reacted promptly and surprised most market participants with a swift increase of 0.75% at the June 2022 Federal Open Market Committee meeting. It was the largest increase since 1994.
As inflation is still rising with few signs of abating, the Federal Reserve with its monetary policy tightening campaign has engineered the fastest increase in 30-year mortgage rates for any six-month period since Fed Chairman Volker era of the early 1980s. In the first half of 2022, 30-year mortgage rates doubled from 3% to over 6%. With additional interest rate increases widely anticipated for the reminder of the year, consumer confidence is decreasing rapidly. While the job market remains relatively strong, predictions for a U.S. recession are growing louder by the day.
As a long-term investor what should we do when confronted with recession fears? How do we handle the accompanying severe market turmoil and sharp drawdowns of our investments that we experienced during the first half of 2022? Consistent with our goal of long-term wealth creation, we should remember that bear markets are unsettling but they do not last long (an average of 15 months) and are typically followed by much longer bull runs. Selling might not be the best option as it is extremely difficult to time re-entry in the market, especially after the traumatic experience of booking losses. However, the Investment Committee at Elevage Partners will not hesitate to exit an investment when its long-term prospects are no longer attractive. In addition, during the first six months of the year, Elevage Partners raised cash levels in our investment models, took profits in some specific positions that had outperformed and reinforced equity names in defensive sectors of the economy.
While this period tests even the most patient investor, we know that market rebound phases tend to be front-loaded. That means missing even a few key days early in a rebound may have a dramatic negative impact on performance. We believe that high market volatility is likely to persist until there are clear signs that inflation is moderating. On the other hand, a significant portion of the necessary financial market adjustments (higher interest rates, equity valuations converging to historical levels) are most likely behind us. Therefore we will continue to rely on our discipline and diversification cornerstones to be positioned to resume wealth accumulation over time.
Should you have any questions regarding market developments or a specific investment, do not hesitate to contact me or your wealth management advisor.
Thierry Hasse, Chief Investment Officer
The information contained herein represents the views of Elevage Partners at a specific point in time and is based on information believed to be reliable. No representation or warranty is made concerning the accuracy of any data compiled herein. In addition, there can be no guarantee that any projection, forecast or opinion in these materials will be realized. Any statement non-factual in nature constitutes only current opinion which is subject to change. These materials are provided for informational purposes only and do not constitute investment advice. Any reference to a security listed herein does not constitute a recommendation to buy, sell or hold such security. Past performance is no guarantee of future results. The historical returns of any securities and/or sectors mentioned in this commentary are not necessarily indicative of their future performance.