Throughout Q2 2022, we saw a continuation of the economic themes from the beginning of the year: Higher prices, slower economic growth, rising interest rates, and ongoing geopolitical tensions. The capital markets extended their losses during the quarter with almost every area of the market, both stocks and bonds, in solidly negative territory for the year. Some areas of the market, such as mid- and small-cap stocks are down almost 30 percent year-to-date. Even bonds are down on the year with intermediate maturities down 10 percent and longer maturity bonds down over 20 percent. There have been very few places for investors to find solace this year. Energy is one of the few sectors of the market that has been positive this year, partly a result of elevated oil prices.
U.S. Market and Economic Review
Inflation in the U.S. accelerated in Q2 2022, rising 8.6 percent in May compared to a year ago. We have not seen price increases this high since 1981. Prices continue to rise broadly across many areas, including energy, food, shelter, and travel. These widespread cost increases have resulted in U.S. workers taking a “pay cut” this year as average hourly earnings are increasing less than inflation. According to the Bureau of Labor Statistics, wage growth adjusted for inflation is down 3 percent over the last year as of May.
Households are spending a larger portion of their income on staples, leaving less for discretionary purchases. Consumer spending, which accounts for about two-thirds of U.S. economic activity, was one of the strongest sectors of the economy in the first quarter but is starting to weaken. Retailers such as Walmart and Target missed quarterly earnings estimates, signs that spending is slowing and rising costs for fuel and other items are eating into profits.
These headwinds are resulting in U.S. economic growth slowing this year. After strong growth in the fourth quarter of 2021, Gross Domestic Product (GDP) fell in the first quarter by 1.6 percent. Concerns over a potential recession increased as we progressed through the second quarter. A recession is defined as two consecutive quarters of GDP declines. Given the fact that first quarter GDP was negative, the chances of a recession are, by definition, elevated. The official report on second quarter GDP growth will be released in late July. Forecasts on where GDP growth may fall for the second quarter vary with estimates in both positive and negative territory.
Meanwhile, the U.S. Federal Reserve (the Fed) implemented its largest interest rate hike in 28 years when it raised the benchmark Fed Funds Rate by 0.75 percent in June. This move followed a 0.50 percent increase in May and a 0.25 percent increase in March. The Fed has been clear in their communications that they will continue to raise interest rates as they try to curb inflation. However, many investors are questioning whether the Fed’s policies are too aggressive and may help push the scales of economic growth into recessionary territory.
Global Market and Economic Review
These headwinds are not limited to the U.S. in Q2 2022 but are also being felt in other countries around the world. Inflation continues to climb in both advanced and developing economies outside the U.S., which has prompted central banks around the world to tighten monetary policy and raise interest rates, similar to the actions taken by the Fed. At an emergency meeting in June, the European Central Bank announced a plan to gradually increase interest rates to tackle inflation. This was a reversal of policy for the region, as rates have been in negative territory for the last few years.
Economic growth around the world is expected to slow during the second half of the year. Several well-respected organizations such as the World Bank, International Monetary Fund, and Organization for Economic Cooperation and Development have reduced their global growth forecasts by varying amounts. Most estimates for 2022 global growth are in the 3 percent range, which is roughly half of last year’s growth.
It is not a surprise that the capital markets are reacting negatively to the trends of slowing growth and rising inflation around the world. We will most likely continue to see volatility in the markets as investors digest economic data and the outlook moving forward. Geopolitical tensions also remain a risk that presents additional challenges to an already-stressed market. We expect central banks around the world to continue raising interest rates to battle inflation. Whether or not this will tilt some world economies into recession remains to be seen.
However, amidst the challenges we are currently facing, we must remind ourselves that periods of negative market returns are inevitable. There will be bumps in the road. But the general long-term trend is positive, and we are coming off of very strong performance in 2019, 2020 and 2021.
What Does This Mean For You?
As we continue to monitor the global economy and capital markets, we remain optimistic about the longer term, but also realistic about headwinds in the shorter term. We know that volatile times such as these require discipline, and it is easy to make emotional decisions about your portfolio or finances. The current volatility highlights the importance of maintaining a prudent asset allocation that is consistent with your long-term financial plan. We also work closely with clients to help advise on major financial decisions and spending during this time, including our recent blog post on finances in a bear market.
Having a sounding board and guide during times of uncertainty can help give you peace of mind and confidence in your financial future. Domani Wealth advisors are always here to have a conversation, provide a second opinion, or offer advice on steps best suited to your goals. If you’d like to start a conversation, please call us at 855-855-5455 anytime, email us at [email protected], or visit our team page to learn more about our wealth advisors.