Quarterly market outlook - 2nd Quarter 2022

Our investment strategists provide the Edward Jones perspective on the latest economic activity and what it may mean for investors.

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Asset class performance chart

Source: Morningstar Direct, 3/31/2022. Cash represented by the Bloomberg US Treasury Bellwethers 3-Month index. U.S. investment-grade bonds represented by the Bloomberg US Aggregate index. U.S. high-yield bonds represented by the Bloomberg US HY 2% Issuer cap index. International high-yield bonds represented by the Bloomberg Emerging Market USD Aggregate Index. International bonds represented by the Bloomberg Global Aggregate Ex USD hedged index. U.S. large-cap stocks represented by the S&P 500 Index. Developed international large-cap stocks represented by the MSCI EAFE index. U.S. mid-cap stocks represented by the Russell Mid-cap index. U.S. small-cap stocks represented by the Russell 2000 Index. International small- and mid-cap stocks represented by the MSCI EAFE SMID index. Emerging markets represented by the MSCI EM index. Past performance does not guarantee future results. An index is unmanaged and is not available for direct investment.

Past performance does not guarantee future results. An index is unmanaged and is not available for direct investment.

A variety of fixed-income and equity assets performed below historical levels in the first quarter of 2022.


First quarter in review

The first quarter of 2022 faced two significant headwinds that soured investor sentiment and sent returns into negative territory:

  1. The Federal Reserve announced a hawkish view on inflation and began raising rates while paving the way for balance sheet reduction later this year.
     
  2. Geopolitical tensions stemming from the invasion of Ukraine by Russia have caused volatility in the commodity market and sent oil prices higher. This also caused food and raw metal shortages as western allies banned Russian goods.

Low investor sentiment weighed on equities – All equity asset class returns in our framework were negative in the quarter. Developed international small- and mid-cap stocks were the hardest hit. U.S. large caps fell as much as 14% before somewhat recovering. Returns ranged from –4% to –9% at quarter-end. Value-oriented shares outperformed growth-oriented names, with high-valuation sectors such as Technology acutely sensitive to a rising interest rate environment.

Rising yields meant disappointing bond returns – The U.S. 10-year Treasury yield quickly surpassed the 2% mark in Q1, sending bond prices lower. Bond yields have risen as investors price in Fed rate hikes. Along with equities, all fixed-income asset classes in our framework, excluding cash, saw negative returns for the quarter. U.S. investment-grade and international high-yield bonds were the worst performers.

Commodities outperformed as inflation heated up – Inflation remained well above the Fed’s 2% target as supply chain disruptions and shortages persisted. Energy prices soared on Ukrainian/Russian tensions, with oil briefly reaching $130 a barrel. Commodities posted a nearly 30% gain in Q1 after already-strong returns in 2021. We think inflation will remain above average before moderating into 2023.

Action for investors

While short-term returns may be volatile, investors could use this period to rebalance or diversify portfolios to align with longer-term strategic allocations..

Household checkable deposits ($ billions)

Source: FactSet

Accessibility description: U.S. households entered the year with nearly $2.9 trillion in excess savings versus pre-pandemic levels.


Economic outlook

Over the past quarter, risks to U.S. economic growth have broadly increased. These include rising inflationary pressures and waning fiscal and monetary policy support.

Rates on the rise – The Federal Reserve began its rate-hiking cycle in March to temper demand and bring down inflation. The central bank likely will raise interest rates at each of the next four to six meetings, including one or more 0.50% rate increases. The Fed will also reduce its balance sheet assets, likely starting in May, which further removes liquidity from the system.

While higher rates can slow the economy by increasing borrowing costs for consumers and corporations, historically there has been a lag impact of about four to eight quarters before the economy faces a meaningful slowdown – and inflation typically moderates during this period, as well.

Consumers still solid – We continue to believe the U.S. economy entered 2022 from a position of relative strength. The U.S. consumer was in good shape coming into the crisis, supported by healthy balance sheets and excess savings of over $2.5 trillion versus pre-pandemic levels. This may help cushion consumers broadly from higher gas and food prices, as well as gradually rising rates.

Growth moderating, but no recession – In our view, the U.S. economy remains in the middle phase of its economic expansion, heading toward late cycle. We see U.S. economic growth in the 2.5% to 3.0% range in 2022. This is down from earlier estimates but still above historical trend levels – and not indicating a recession.

Q1 economic growth may be in the 1.5% range, weakened by the omicron variant and higher oil and commodity prices. However, we may see better growth in the months ahead, as re-opening demand picks up and commodity prices potentially stabilize.

Action for investors

While risks to economic growth have increased, we still do not anticipate a recession in the U.S. this year. We expect U.S. growth to rebound in Q2, which could support better market performance in the quarter ahead.

Earnings support stocks even with valuations under pressure

Source: FactSet, Edward Jones, 3/25/2022

A recent bull market has been supported by rising corporate profits.


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Equity outlook

Market conditions shifted in Q1 and the S&P 500 experienced its first correction since stocks bottomed two years ago. While headwinds are growing, we think the bull market remains well supported by solid economic growth and rising corporate earnings. As the cycle advances, we recommend remaining opportunistic but with increased focus on quality and diversification across asset classes and sectors.

Volatility likely to stay elevated – Heightened geopolitical uncertainty and the prospects for an aggressive Federal Reserve rate-hiking cycle remain key sources of market volatility. A potential de-escalation of the tragic situation in Ukraine is likely to help sentiment, but rising bond yields could continue exerting downward pressure on valuations as the cost of money rises. During the last five Fed tightening cycles since 1985, the S&P 500 price-to-earnings ratio declined on average 20% between the first and last Fed rate hikes.

Upward earnings trajectory intact – Rising corporate profits can help sustain the bull market and provide an offset to falling valuations, in our view. While earnings growth will continue to moderate from a historically elevated level, the uptrend will likely persist this year, supported by a growing economy, resilient profit margins and healthy corporate balance sheets.

Equities can be a long-term inflation hedge – Companies with pricing power typically see their revenue and earnings rise with inflation over time. Because of this dynamic, an appropriate allocation to equities can help investors maintain their purchasing power. We continue to slightly favor value-style investments that can benefit from high inflation and rising yields. However, as growth slows and inflation moderates later this year or in 2023, we expect leadership to change, favoring growth investments that have lagged so far this year.

Action for investors

We believe an allocation in the middle of the equity/fixed-income range is appropriate. As the cycle advances and growth moderates, we are cautious on U.S. smallcap stocks and neutral on U.S. large-cap stocks. We also slightly favor value investments, including exposure to defensive sectors. Globally, we favor emerging market equities, as they have catch-up potential and could benefit from loosening monetary policy in China.

Bond returns during Fed rate hike cycles

Source: FactSet

Bond returns have varied noticeably during the Federal Reserve’s interest rate hike cycles over the past 40 years.


Fixed-income outlook

After two years of ultra-low interest rates, more than 10 years of above-average bond returns and over a quarter-century since the bond market faced such an abrupt series of interest rate hikes, yields are rising on the back of high inflation and monetary policy tightening. We think there is scope for rates to move higher from here, but at a more moderate pace.

Yield curve signaling caution – The yield curve (10-year rates minus two-year rates) has been a credible – though not infallible – signal of economic downturns over time. The curve inverted in April, reflecting tighter Federal Reserve policy at the short end of the curve and softer economic growth expectations on the longer end. We’re not dismissing this signal, but we’d caution against overreaction. We’ve seen the yield curve flatten sharply in the past without producing a prolonged economic or market downturn. We think short-term rates are already pricing in significant rate hikes. Meanwhile, the Fed’s balance sheet reduction could allow longer-term rates to rise, though we don’t expect a dramatic move higher in 10-year yields.

Rising rates have bonds down but not out – The recent jump in rates has weighed on bond returns, with both stocks and bonds logging declines in Q1. We think rates have adjusted to the inflation and Fed policy environment, indicating to us that bond returns don’t have to remain under such pressure indefinitely.

Looking at prior instances when 10-year rates rose by roughly 1.5% in a short period of time, bond returns were resilient following pullbacks, delivering an average return of 8.0% over the following 12 months.* We don’t expect fixed-income returns to be quite that strong ahead, but as this chart shows, prior Fed tightening cycles have seen moderate bond gains. During those periods, bonds provided valuable portfolio protection against elevated equity market volatility.

Action for investors

We recommend a neutral allocation to fixed income, using recent volatility as an opportunity to rebalance to a long-term target position. We favor U.S. investment-grade bonds given economic and credit conditions.

Global central bank policy rates (year-end forecasts %)

Source: FactSet

Many major global central banks are raising rates to fight inflation, but China is an exception.


Rising interest rates influence everything from consumer spending to the performance of fixed income and equity markets. Edward Jones can help you optimize your portfolio accordingly. Find a Financial Advisor.

International outlook

We see global economic growth moderating to the 3.0% range, down from nearly 6.0% in 2021, as central banks around the world begin to raise rates to contain rising inflation.

China in easing mode – Major central banks like the Bank of Canada, Bank of England and Bank of Korea have all started their rate-hiking cycles alongside the U.S. Federal Reserve. One exception is the Chinese central bank, which plans to cut rates this year to support economic growth in the economy.

Europe impacted more by Ukraine crisis – The European central bank (ECB) has also held off on raising rates despite rapidly rising inflation, as the region’s economy remains relatively more exposed to the crisis in Ukraine. Not only is Europe a larger importer of Russian oil – making up nearly 40% of its natural gas imports – but it is also a larger trading partner with Russia and Ukraine. Markets have reflected some of this risk as well. European equity indexes have underperformed this year, and credit spreads have widened more than in the U.S., indicating a generally higher risk of corporate defaults.

Emerging markets on the radar – While rising inflation and geopolitical uncertainty represent growing risks to the global economy, we see opportunities forming in emerging-market (EM) assets. Valuations are more favorable at these levels, and major EM economies such as China are taking active steps to support economic growth. EM economies that are exporters of commodities, such as Brazil, will benefit from rising commodity prices broadly. If the geopolitical crisis de-escalates over time and pandemic trends improve, emerging markets may also benefit from a potentially softening U.S. dollar, which has been supported in part as a safe-haven asset through the geopolitical crisis.

Action for investors

While we remain neutral on non-U.S. developed markets, we see opportunities in emerging markets and recommend an overweight position in EM equities to complement domestic portfolio exposure.

Similar gas prices but higher disposable income

Source: FactSet, Edward Jones, 3/25/2022

The impact of higher gas prices has been dinted by higher disposable incomes.


High commodity prices: What’s the impact?

The conflict in Ukraine and sanctions against Russia, a major exporter of natural resources, have triggered supply disruption concerns and caused prices to rise. Oil prices briefly spiked in March to $130 per barrel, gas prices surpassed $4 a gallon (on average nationwide), and wheat, aluminum and nickel all hit record highs. A potential resolution or de-escalation of the crisis could help reverse the recent gains. But even if prices persist at current levels, we believe the economy can stay resilient without falling into recession as growth slows.

Solid foundation provides a cushion – In the past, major commodity price shocks have started or accelerated recessions. This time, the economy had a strong foundation heading into the geopolitical crisis. Oil and gasoline are at similar prices as in the three years between 2011 and 2013 (the most recent stretch of near-record prices), but consumers’ disposable income is 50% higher. Unemployment is near record lows, and job openings are at record highs, pointing to strength in the labor market that is unlikely to fizzle soon. Also, household debt relative to income is low, and savings are high.

Sensitivity to oil price shocks is lower – The U.S. economy is less than half as energy-intensive as it was in 1982. And the shale revolution of the past decade has helped make the economy more resilient to oil price shocks. Higher oil prices and production can contribute to economic growth, partially offsetting consumer spending.

Slower growth and higher inflation ahead – High energy prices act as a tax on the consumer, reducing purchasing power and consumption. If the spike in prices persists or accelerates, we expect downside surprises to growth and upside surprises to inflation. But we expect inflation to start moderating in the second half of the year.

Action for investors

An appropriate allocation to equities can help protect portfolios against inflation’s impact over time. We think equities with pricing power and rising dividend income potential are attractive in this environment.

Strategic asset allocation guidance

Our strategic asset allocation represents our view of balanced diversification for the fixed-income and equity portions of a well-diversified portfolio, based on our outlook for the economy and markets over the next 30 years. The exact weightings (neutral weights) to each asset class depend on the broad allocation to equity and fixed-income investments that most closely aligns with your comfort with risk and financial goals.

Equity diversification and Fixed-income diversification pie charts

Description: Equity diversification and Fixed-income diversification pie charts


Opportunistic asset allocation guidance

Our opportunistic asset allocation represents our timely investment advice based on current market conditions and our outlook over the next one to three years. We believe incorporating this guidance into your portfolio may enhance your potential for greater returns without taking on unintentional risk.

Equity and Fixed income underweight, neutral, overweight tables

Diversification does not ensure a profit or protect against loss in a declining market.

Description: Equity and Fixed income underweight, neutral, overweight tables


Investment performance benchmarks

It’s natural to compare your portfolio’s performance to market performance benchmarks, but it’s important to put this information in the right context and understand the mix of investments you own. Talk with your financial advisor about any next steps for your portfolio to help you stay on track toward your long-term goals.

Asset class performance table

 

U.S. equity sector performance table

Source: Morningstar Direct, 3/31/2022. Cash represented by the Bloomberg US Treasury Bellwethers 3-Month index. U.S. investment-grade bonds represented by the Bloomberg US Aggregate index. U.S. high-yield bonds represented by the Bloomberg US HY 2% Issuer cap index. International high-yield bonds represented by the Bloomberg Emerging Market USD Aggregate Index. International bonds represented by the Bloomberg Global Aggregate Ex USD hedged index. U.S. large-cap stocks represented by the S&P 500 Index. Developed international large-cap stocks represented by the MSCI EAFE index. U.S. mid-cap stocks represented by the Russell Mid-cap index. U.S. small-cap stocks represented by the Russell 2000 Index. International small- and mid-cap stocks represented by the MSCI EAFE SMID index. Emerging markets represented by the MSCI EM index. All performance data reported as total return.

An index is unmanaged and is not available for direct investment. Performance does not include payment of any expenses, fees or sales charges, which would lower the performance results. The value of investments fluctuates, and investors can lose some or all of their principal. Past performance does not guarantee future results.