Q2 2022 - Market Review

Casualties Of Recent Turbulence

Once again, it’s been a quarter to test the mettle of investors. Inflation hasn’t been “transitory” as many thought it would initially be. In response, central banks around the world have been putting up interest rates like they’re going out of fashion. Unfortunately for investors, rising interest rates can leave few places to hide.

The global stock market, as it often is, has been the biggest casualty of recent turbulence. It’s fallen 15.7% in the three months to 30 June 2022. To put this into context, that’s the eighth biggest quarterly fall in the last 50 years. The global bond market held up better, as it usually does, but still dropped 8.3%. That’s contributed to the biggest global bond market drawdown (peak-to-trough decline) on record.

So to those who’ve stayed invested (as we think is the best thing to do – more on that later) despite recent troubles, you’ve shown more resilience than many others. Staying calm and focused on the long term is easier said than done when the going really gets tough. Although a recovery will come, no one knows when that’ll be and we could see further declines in the meantime. Those who can stay the course, however, are usually rewarded by the markets in the end.

Equities Review:
‍‍USA and Tech Sink, China Swims

Not one of the eleven major stock market sectors posted positive numbers during the second quarter of 2022. The Telecommunications Services sector and the best performer year-to-date – Energy – came closest with returns of -3.1% and -5.2%, respectively. At the more unfortunate end of the performance chart were Information Technology and Consumer Discretionary (non-essential consumer goods and services) with slumps of 21.7% and 20.2%, respectively. This is a real reversal of fortunes, as Energy and Telecoms were the two worst performing sectors over the past 10 years, whereas Technology and Consumer Discretionary were two of the best.

It was a similar picture for the main equity factors, with all of them ending the quarter underwater. None of the factors even came close to a gain though, with the ‘minimum volatility’ factor (companies whose shares bounce up and down less than the market average) falling the least with a 9.3% decline. The biggest drop came from the ‘momentum’ factor (companies whose shares had risen the most in the past 6-12 months) with a 18.6% slump.

These relative performances are in line with expectations given the current market environment. As the name suggests, minimum volatility tends to do relatively well in volatile periods. Momentum usually works best in rapidly rising markets, and they’ve been anything but recently.

One area that managed to buck the downward trend, however, was the Chinese stock market. After falling significantly in 2021 when most other markets rose strongly, it reversed its decline and rose 3.4% as lockdown restrictions in the country finally began to ease. Like Technology went from the best performer sector over ten years to the worst performer this quarter, so too did the US stock market with a fall of 16.9%. A growing number of commentators say the US is heading towards recession and that’s being reflected in its stock market performance.

Bonds & Alternatives Review:
‍No Safe Havens This Time

Often when stock markets are having a tough time you’ll find bonds and alternative investments doing well instead. Not so this quarter. The global bond market had its worst quarter on record, with an 8.3% decline. This was the fourth quarter in a row it’s fallen. The root cause? Rising interest rates. Bond prices and interest rates usually travel in opposite directions, so as interest rates have gone up, bonds have gone down and down.

Hardest hit over the past three months were inflation-linked bonds with a 14.0% drop. This might seem counter-intuitive. Don’t they rise with inflation, which has been going up rapidly? While this is true, inflation-linked bonds aren’t immune to interest rate movements. In fact, on average they’re more sensitive to interest rates than conventional bonds due to their higher duration. So the negative impact of rising interest rates has weighed far more heavily on them than inflation.

Our portfolios, however, invest in a shorter-maturity inflation-linked bonds, which are less sensitive to interest rates. That’s why they were the best performers among bonds during the quarter, followed by shorter-maturity fixed-income bonds. Although both fell (3.4% and 5.5%, respectively), in relative terms this was a decent result.

Gold held up better than both the global stock and bond markets, but in keeping with this quarter’s playbook, it still slumped 7.6%. For yet another quarter though, commodities performed better than all of them. While commodities have posted impressive gains year-to-date, particularly driven by soaring energy prices, they still stumbled over the past three months with a 5.7% decline. All of that pull back came at the end of the quarter, when they fell by 10.8% in a month – a reminder of how volatile commodities can be.

Our thoughts

Speaking of how volatile something can be, a small note on cryptocurrencies. We’ve previously written about why we never invested in them, and recent performances and headlines reaffirm our belief in their speculative nature. Bitcoin, for example, tumbled an eyewatering 56.6% in the past three months alone. Some cryptocurrency investors were even worse off. So-called ‘stablecoin’ Terra LUNA collapsed to zero.

This highlights why we think you should only invest in things you fully understand, that actually have a fundamental value, and there’s a long track record to analyse. We know, for example, the global stock market has declined 20% or so once every five years on average, but has always recovered. Bonds provide investors with real cash payments in the form of interest coupons. Gold has been around for millennia and its price is extremely unlikely to go even close to zero.

Established financial markets have proven their resilience, no matter what’s been thrown at them. Interest rates, inflation, recessions, wars, and even the odd pandemic can put a big dent in them from time to time. Fortunately for investors though, they tend to go up more than they go down. That’s why people who stay invested in markets that have stood the test of time, when everyone else is panicking or chasing the ‘next big thing’, are often those who end up with the best investment results.