“You get recessions, you have stock market declines. If you don’t understand that’s going to happen, then you are not ready, you won’t do well in the markets.” – Peter Lynch 

The alarm bells are sounding and the word “recession” is being thrown around like free samples at Costco – online searches for “recession” have already reached levels comparable to what they were during the Great Recession. Is it too early to assume it is inevitable?  

The second quarter was no better than the first, as the headwinds facing the global economies only intensified. Surging global inflation, hawkish central banks, supply chain struggles, a war between Ukraine and Russia, and China’s zero-COVID policy are just a few of the many factors negatively affecting the global economic outlook, as markets have continued their negative performances to start the year. April saw an immediate retreat, with the S&P 500 falling 8.7% for the month. The selling continued into early May, but the market staged a modest rebound as the month continued. However, this proved temporary as June brought a CPI report that showed inflation rising over 8.6% year-over-year. The highest reading since 1982 prompted the violent reversal of the late May gains as the Fed announced its largest interest rate increase in the last 28 years of 75 basis points. This forced US equities sharply lower as the S&P had its worst weekly performance since March of 2020, with all sectors down over 4% lead by energy which was down over 17%. The first half finished with the S&P 500 down 17.4% for the quarter and right under 20% for the year, the Dow down 12.17% for the quarter, 14.4% for the year, and the NASDAQ down 23.5% for the quarter and just under 30% for the year. All in all, the S&P 500 had its worst first half performance since 1970, and the NASDAQ had its worst since the tech bubble in 2002, as the rise in interest rates continued to weigh disproportionally on technology and growth.  

To add to the chaos, the bond market, which traditionally serves as a reprieve from the volatility, had just as tough of a first half. The 10-year Treasury yield jumped to 3%, after starting the year just below 1.5%, but even more telling and disruptive is the movement of shorter-term Treasury yields: 1-year T-Bills are up over 640% and the 2-year Treasury Notes are up over 300% YTD, as both now hover near 3%. Though rates have skyrocketed, and the movements have been drastic, rates are still at very reasonable levels compared to historical averages. However, these large and swift rate increases have sent bond prices plummeting, with the U.S. Aggregate Bond Index falling over 10% in the first half of the year. The most difficult bond market of the last 40 years has given us 20 consecutive weeks of outflows as investors grapple with these rising rates, ditching bonds and causing bond prices to plunge as the supply of lower yielding bonds rise. Coupled together, the  traditional 60/40 portfolio that is designed to withstand bouts of volatility was down 17% in the first half, which puts this year near rare air, as the only time this portfolio has been down 20% was during the Great Depression. These issues have left investors with no places to hide, as both equities and fixed income have all experienced negative performances this year, and cash in this inflationary environment will most likely lose as well.   

Although the first half of the year has left many feeling pessimistic, historically, these times have led to positive futures. Q2 was the ninth quarter post World War II where the S&P 500 fell more than 15% – historically, over the next quarter, the S&P has been higher 7 out of 8 times, with an average return of 6.22%. It has also been higher all 8 times over the next 6 months and year, returning an average of 15% and 26%, respectively. Of course, that does not guarantee any sort of immediate success, but it does show that it is not uncommon for equities to have strong rebounds following horrible periods.  

Recently, the Fed has made one thing very clear: inflation will be its primary focus as it aggressively raises rates. Another 9.1% jump in inflation this month should lead to continued aggression from the Fed. The biggest question mark has been whether the Fed will be able to achieve its famous “soft landing” all continue to hope for. The degree that inflation can moderate over the coming months should have significant influence on the path ahead for the Fed, resulting in a wide range of potential equity market outcomes over the next 6-12 months. Until inflation abates and further Fed policy is clarified, volatility will likely continue. In volatile times, investors are forced to get back to the basics and evaluate companies based on their valuations and earnings growth, which is exactly what we continue to do. Though inflation will continue to lead to choppy seas, the long-term investor should continue to see opportunities to accumulate high quality, favored stocks. Unfavorable market and economic conditions come and go – these should come as no surprise, nor should they deter investors from their long-term goals. Now more than ever, experience in the market pays off. Proper diversification and quality companies will get through this cycle, just as they always have. Over the long run, investors should remain patient and remember Warren Buffet’s words, “be greedy when others are fearful.” 

John Webb 

Financial Advisor 
Pinnacle Asset Management
Raymond James Financial Services 

Kidd Private Wealth Group