In this month’s blog, Andy Kaufman, CCM’s chief investment officer, shares his key takeaways from the financial markets difficult start to 2022 and what he expects for the rest of the year.
Going into 2022, CCM anticipated that higher inflation, central bank tightening, new variants of the virus that causes COVID-19, and labor shortages would be the main drivers effecting markets. Our thesis was pretty accurate.
The first half of 2022 was marked by extreme volatility in both the equity and fixed income markets. In the second quarter, we began to see the effects of higher interest rates and inflation take a toll on the economy. The rate of inflation continued to rise throughout the first half, accelerating through June to levels not seen since the early 1980s. Subsequently, the Federal Reserve (Fed) raised the federal funds rate in June by 0.75%, the greatest one-time increase in over 25 years, to 1.75%. Despite signals that the economy is slowing, the Fed has stated its intention to remain diligent in combatting inflation.
Second quarter asset flows seemed to support increased levels of market fear and concerns over the implications of higher-than-expected inflation. With credit spreads widening to levels not seen since 2012 and the worst half-year performance in the S&P 500 in 50 years, both the credit and stock markets looked to be signaling a recession. Estimates for second-half of 2022 economic growth have been lowered as evidence points to the stress of greater inflation and higher interest rates. CCM’s base case scenario expects gross domestic product growth to be between 0.5% to 1.0% at year end.
Looking ahead to the remainder of 2022, we believe volatility across markets may remain high for the following reasons (among others):
- Inflation and rising rates. These longer-term issues will widely depend on the Fed’s path of raising the fed funds and the speed of quantitative tightening.
- Geopolitical risk. The war in Ukraine and its effects on commodity prices, supply chains, and defense spending could have major long-term ramifications for asset levels.
- China. The country’s major internal property markets issues could put stress on its banking sector and overall growth. Further, the FBI and MI5 recently issued a joint statement on the threat China poses to U.S. and U.K. interests. This statement coupled with the ever-growing tensions in Hong Kong only increases the chances of potential conflict, therefore, heightening financial market risk.
- U.S. mid-term elections in November. The balance of power between Democrats and Republicans in the Senate and House is at stake. If Republicans maintain majority of one, which we believe is likely, it will inhibit the Democrats’ ability to pass legislation for the next two years. If this proves wrong, it could add to further market volatility with looming tax hikes and public spending.
While it has been a trying start to 2022, CCM is positioned accordingly and looks forward to seeking relative opportunities during the second half of 2022.