Newsletter
Dear Client,
The first half of 2022 proved to be tumultuous. It was the worst start of the year for U.S. stocks since 1970, and the biggest selloff in bonds in four decades. Yields surged to multiyear highs as major central banks around the world moved to tighten monetary policy in response to a multidecade high in inflation. Federal Reserve officials began the year with “transitory” inflation projections that in hindsight were woefully inaccurate, leading them to fall behind the curve in combating rising prices. After falling behind the inflation curve, the Fed has now been forced to play catch-up in the form of 1.5% worth of interest rate hikes with more to come. Investors looking for relief have found few safe havens. The once red-hot areas like cryptocurrencies and SPACs have imploded. Even gold, long considered an inflation hedge, has posted a negative return this year.
Talk of recession has increased notably over the past few weeks culminating with Fed Chair Powell’s Congressional testimony where he explicitly warned of the possibility. This prevailing market concern can be evidenced by the recent decline in both oil and interest rates signaling that perhaps “peak Fed” has been reached (in terms of aggressive rate hikes), which could be supportive for markets going forward.
While there has been much attention paid to potential recession, risks elsewhere in the world could roil markets as well. The European Central Bank has sought to stave off a resurgent sovereign debt crisis with the promise of a new plan to support Italy. Meanwhile Japan may finally be forced to concede and allow its bond yields to rise, abandoning its bond yield controls, which have shielded it from tightening global monetary policy and trounced the Yen. Better yields at home would spur the country’s investors to repatriate cash that has poured overseas, pushing the Yen up and prices everywhere else down.
Markets struggled in the first half, facing a multi-decade high in inflation, aggressive monetary policy tightening by Federal Reserve, and the effects of the Russia/Ukraine war. Meaningful countertrend rallies may continue this year, but aggressive Fed policy, decreased liquidity, and slower economic growth will likely keep pressure on stocks. Weakening earnings and margin outlooks could be the catalyst for another leg down in the market. Given this backdrop of high inflation, higher short-term interest rates, and weakening growth outlooks, we prefer companies with strong free cash flow, healthy balance sheets, and positive earnings growth. With that being said, an argument can be made that given the significant compression we’ve already seen in price-to-earnings multiples, if the slowdown doesn’t turn into a contraction, then stocks have likely bottomed. Regardless, markets are expected to remain volatile for the balance of the year, and we will look to utilize that volatility to deploy excess capital into compelling opportunities. As always, we thank you for your continued support.
Regards,
Edge Wealth Management
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