The U.S. financial markets were quite weak in the first quarter, with broad-based stock and bond indexes down roughly 5% and 6% respectively during the period. April saw an acceleration of the equity market decline, with the S&P 500 index and NASDAQ composite index down 8.7% and 13.2% respectively for the month.
The damage done to fixed income investments thus far in 2022 has been severe, with the benchmark government/corporate bond index down 9.4% on the year. The yield on the index at the start of the year was slightly more than 2%, which has provided a scant cushion to the nearly 10% price decline of the index.
The sharp rise in interest rates also impacted the stock market, particularly those growth companies that hadn’t yet reached the stage of generating positive cash flows or net income. Raising the discount rate for those future earnings makes the earnings less valuable in present day terms, and this re-rating of growth stocks might continue if rates continue to rise from present levels. Value stocks in general have held up well thus far this year; energy stocks have been quite strong amidst the oil and gas price impact of Russia’s invasion of the Ukraine.
As the year has progressed, the Fed has been consistent on their need to raise short-term interest rates to slow the economy and reduce the historically high level of inflation. The interest rate futures markets are assigning a near certainty that the discount rate will be raised by 50 basis points this month, and the expectations are this rate will reach 2.5% by year-end.
We recognize that the investment background has changed dramatically, and not just as a result of war breaking out in Eastern Europe. After nearly forty years of declining interest rates, investors are now seeing the negative impact of rising rates on bond prices and long-duration equity values. A rapid increase in mortgage rates from 3% earlier this year to 5% at present has slowed down the refinancing markets substantially while housing prices remain stubbornly high. There are labor shortages broadly across U.S. industries, and the recent success of unionization efforts at Starbucks and Amazon signals a change in the relative relationship of labor versus capital. Still, the roughly 5% increase in annual wages has been more than offset by the near 8% increase in the Consumer Price Index.
The Federal Reserve board has a tricky challenge unwinding the unprecedented level of monetary stimulus administered to sustain our economy during the pandemic. The Fed must raise rates enough to slow down inflation, but not so much as to throw the U.S. economy into recession. While there have been periods of Fed-initiated rate increases over the past decade, these hikes were not in response to inflation but rather an effort to slow down economic growth. This time might truly be different, and it’s possible after 40 years of steadily declining interest rates that we are at the start of a new era of rising rates.
The information contained in this communication is provided for general purposes only, and was prepared in reliance on independent, third-party sources that Fairview Capital Investment Management, LLC (“Fairview Capital”), an SEC-registered investment adviser, believes are reliable. Nevertheless, Fairview Capital does not guarantee its accuracy or timeliness of any information provided herein. The information reflects subjective judgments, assumptions and Fairview Capital’s opinion on the date made and may change without notice; Fairview Capital is not obligated to update this information. Nothing in this communication should be construed as investment or tax advice, a solicitation, offer, or recommendation, to buy or sell any security. Investment management services are offered only pursuant to a written investment management agreement, which investors are urged to carefully read and consider in determining whether such agreement is suitable for their individual needs and circumstances. The information in this communication should not be construed as an endorsement, recommendation or sponsorship of any company or security. If this post mentions a specific investment or security, we or our affiliates may have a position in that security (either long or short), and we may profit from a price change in that security.
Investment management and advisory services–which are not FDIC insured–are provided by Fairview Capital. Any links provided to other sites are offered as a matter of convenience and are not intended to imply that Fairview Capital or its affiliates endorses, sponsors, promotes and/or is affiliated with the owners of or participants in those sites, or endorses any information contained on those sites, unless expressly stated otherwise. All investing involves risk, including the possible loss of money you invest, and past performance does not guarantee future performance. Please see Fairview Capital’s Form ADV Part 2A and Form CRS for important details.