Inflation, Geopolitics, and Rising Rates Weigh on Markets in the First Quarter
After a historically calm 2021, volatility returned in the first quarter of 2022, as inflation surged to 40-year highs, the Federal Reserve promised to raise interest rates faster than previously thought, and Russia surprised the world with a full-scale military invasion of Ukraine, marking the first major military conflict in Europe in decades. Those factors fueled a rise in volatility and pushed stocks lower in the first three months of the year.
Broad market volatility began to pick up during the first few days of 2022 as inflation readings hit multi-decade highs, confirming that price pressures were still accelerating. That prompted multiple Federal Reserve officials to signal that interest rates will rise faster than markets had previously thought, including a possible rate hike in March. The prospect of sooner-than-expected interest rate hikes weighed on the sectors with the highest valuations, specifically growth-oriented technology stocks. The steep declines in the tech sector exacerbated market volatility in January.
Additionally, while the fourth-quarter earnings season was solid, several large, widely held technology companies posted disappointing results or forecasts. Finally, in late January at the FOMC meeting, Fed Chair Powell clearly signaled that the Fed would be raising rates at the next meeting (in March), confirming to investors that interest rates were going to rise much more quickly than had been assumed just a few months prior. The S&P 500 ended January with the worst monthly return since March 2020 (the onset of the pandemic).
Volatility remained elevated in February, with the market’s primary concern shifting from monetary policy to geopolitics as Russia amassed troops on the Ukrainian border, prompting warnings from the United States and other Western countries of an imminent invasion. Then on February 24th, the warnings were fulfilled as Russia invaded in the early morning hours. The conflict sent essential commodity prices such as oil, wheat, corn, and natural gas surging as commodity producers and end-users feared production disruptions and reduced supply. As one would expect, markets dropped in response to the invasion, not just because of rising geopolitical concerns, but also as investors realized higher commodity prices will only add to existing inflation pressures and in turn, possibly pressure corporate earnings and consumer spending.
Markets remained volatile in early March, as hopes for a relatively quick ceasefire in Ukraine faded and commodity prices stayed elevated. Shortly after Russia’s invasion, the developed world united in a never-before-seen way against Russia, imposing crushing economic sanctions on the Russian economy. But while that demonstrated important unity against Russian aggression, it became clear that the sanctions would also harm Western economies, especially in the EU, which raised concerns about a global economic slowdown.
However, stocks did mount a strong rebound in late March thanks to incrementally positive geopolitical and monetary policy news. First, the Ukrainian resistance stalled the Russian advance, and while the situation devolved into an intense humanitarian tragedy in Ukraine, fears of the conflict extending beyond Ukraine’s borders faded over the course of the month. Then, on March 16th, the Federal Reserve raised interest rates by 25 basis points, the first-rate hike in over three years. But the rate hike was no worse than markets feared, and that provided a spark for a “relief rally” in stocks that produced a positive monthly return for the S&P 500 and carried the major indices to multi-week highs by the end of the quarter.
In sum, the first quarter of 2022 was the most volatile quarter for markets since the depths of the pandemic in 2020, as numerous threats to economic growth emerged. As we start the second quarter, investors will need to see incrementally positive progress across geopolitics, monetary policy expectations, and the outlook for inflation if the late-March rally is to continue.
Second Quarter Market Outlook
As we start a new quarter, there are plenty of uncertainties regarding high inflation, rising commodity prices, rising interest rates, and the Russia-Ukraine war. But while there are risks, it’s important to note that the U.S. economy is very strong. Unemployment remains historically low, and that reality is helping support asset markets. Additionally, interest rates are rising but remain far below levels where most economists forecast that they will begin to slow the economy. Finally, consumer spending, which is one of the main engines of growth for the U.S. economy, is robust, and corporate and personal balance sheets are healthy.
In sum, the outlook for markets and the economy is uncertain, and we should all expect continued volatility across asset classes in the short term. But core macroeconomic fundamentals remain very strong with U.S. corporations and consumers are, broadly speaking, financially healthy. So, while risks remain, as they always do, there are multiple positive factors supporting markets. It is important to remember that a well-executed and diversified, long-term financial plan can overcome bouts of even intense volatility like we saw in the first quarter.
At HCO Private Wealth, we understand the risks facing both the markets and the economy, and we are committed to helping you effectively navigate this challenging investment environment. Successful investing is a marathon, not a sprint. Even temporary bouts of volatility like we experienced over the past three months are unlikely to alter a diversified approach set up to meet your long-term investment goals.
Please do not hesitate to contact us with any questions, comments or to schedule a portfolio review.