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The Cornerstone Investment Commentary: 2nd Quarter 2022

On June 30th, global stock and bond markets ended their worst first-half performance since 1970, albeit with some silver linings in what many see as only very dark clouds.  However, the sentiments that ‘the worst is over’ and ‘the worst is yet to come’ seem balanced on a knife’s edge.  Our view favors the former.

While it may seem that little has changed since our June 17th email message to you (“Inflation, Interest Rates, Recession and Portfolio Strategies”, for which we thank you for the many thoughtful questions and positive comments), a look beneath the surface begins to indicate otherwise.  Events since then suggest we are on the right track.  To spell out a few of these as of June 30th:

  • Since mid-June when the Federal Reserve raised rates more than expected (0.75%), market interest rates have fallen.  The overall bond market gained over 2.5%, and intermediate U.S. Government bonds rose over 3% (25% more than corporate bonds).  How is this possible?  Because what now matters are actual events relative to the expectations of events, rather than the events themselves.  And the Fed’s move lowered expectations about how far rates will rise by early 2023.  This is why our recent pivot to intermediate U.S. Government (from corporate) bonds has started off so well.
  • Since the Fed’s mid-June surprise with its aggressiveness, global growth stocks (2022’s laggards, by far) have gained 6% while global value stocks are flat.  This is what we would anticipate when such expectations shift and why our recent rebalancing favored (U.S.) growth stocks.
  • Data shows that consumer spending/demand has slowed since January, signaling the Fed’s actions are already working.  The sooner this happens, the less ‘Fed medicine’ is expected to be needed.
  • Remember that when supply falls, prices rise.  This is Economics 101.  And while inflation data is convincing that the biggest price jumps since January are tied to global supply cuts from Ukraine (wheat, food) and Russia (oil, natural gas), a pattern is emerging that ‘core’ inflation is moderating significantly.  It’s up just 1.2% from FEB-MAY, a 3.7% annual clip.  Behavior the Fed is able to influence is being influenced.  This is what the Fed, bonds and (growth) stocks all want to see.
  • Not surprisingly (to those who are watching), so-called ‘inflation hedges’ have now fallen hard – down 20% from their early Spring peaks.  Even inflation-linked bond values (TIPs) have performed 25% worse than similar non-inflation-linked Treasuries since early March.

We realize any of these could reverse course at any time.  However, the die appears on its way to being cast.  It seems more a matter of ‘when’ (not ‘if’) they take hold for good.  Even if a recession occurs – a good environment for U.S. Government bonds – it only means additional patience is required during the ‘storm’.  Of course, it takes a well-designed ‘shelter’ to protect the money you need while enduring such times, and your largest conservative holdings (VGSH/SCHO) have been among 2022’s best in that regard.

We will continue watching how markets react to all the various economic events that unfold, mindful that their path is far from certain.  With hopes and wishes for a pleasant and/or restful summer, we thank you for the continuing opportunity to work with you.