The Monthly Mosaic | May 2022


There's no soft way to put this at the start of the second quarter has been a very difficult time for the markets, both stocks and bonds. So certainly coming into the quarter, there was a little bit more positivity, we had a nice sizable rally at the back half of March in the s&p 500. But then immediately in April, we started to see some other signs that maybe inflation was going to continue to remain high. We got the manufacturing Price Index, which was a very large jump up in terms of what that was the previous month. And then we started to move into more Fed President started to speak, more concerned about inflation, potential for raising interest rates even greater than 50, maybe 75 basis points, all that alarmed the equity markets to a large degree. And then finally, we started to see more and more severe lockdowns in China hitting back at the supply chains. Again, another inflationary aspect of that looks like it may be going higher. So every time we see a data point that throughout this first half of the quarter that we've seen an inflationary data point that was negative, the equity markets have sold off. So it continues to be a market-driven by volatility really spurred by the inflation outlook. And what we have coming forward.

The Fed is really has a big challenge in front of them in terms of what they're up against because they know and they've admitted so that they don't have tools to fight supply issues, right. So the Fed can only control the demand side of the economy, which is the reason why the markets have become much more volatile. The market sees that as the only way they can handle this is to destroy demand that it's alarming from a recessionary standpoint. So they really are going to have to be able to thread the needle in terms of raising interest rates up enough to start to destroy demand a little bit to bring inflation down, but not too much so that it tips the economy into recession. That's what the equity markets are trying to figure out. And why it's become so volatile here over the last month and a half.

Bond markets have had a very, very difficult start to the year, the aggregate bond index is up over 10%. So certainly there's been a lot of surprises and conservative investors portfolios are looking at their accounts that have a lot of bonds, they're seeing larger price decreases, through a lot of the quarter was even larger than the equity market. But as we moved into this point in time now we do think there are some signs that inflation has probably peaked. Interest rates have adjusted to a large degree to really reflect a very aggressive Federal Reserve. So in our eyes at this point in time, we don't see a lot of material downside in bond prices from here, we think, largely that the interest rates have had adjusted, there's actually pretty decent yields out there to be had at this point in time.

One other thing that helps our outlook for bonds, again, it's the economy is slowing, not alarmingly. So that's just where we're coming off a very high growth rate, we're kind of getting back into what the normal side is going to be. So we do see the economy slowing, especially on the good side. And along with that economy slowing you'd like you would believe that inflation has peaked likely to start subsiding. So that should have some support for bond markets, especially on the interest rate side, if you do get that slowing the Fed is going to be again, very cautious. If participants see that the economy slowing inflation is cooling, you'll start to see some of those price hike anticipations come back out of the market, which would be supportive for bond prices and likely stock prices as well.

We do think that volatility is here to stay as long as this inflationary situation is really kind of with us. And again, every data point that has to do with inflation is heavily scrutinized. Anything that again shows an ebbing in inflation is going to be supportive for risky assets. I think the important thing to think about is that the S&P so far here has drawn down nearly 18% at its worst point this year from peak to trough. That's a very sizeable correction outside of a recession, we had around about a 19% decline in 2011, another 18 to 20% decline in 2018. So this is a large correction, we do anticipate that there'll be more volatility but as long as we can avoid a recession, you know, equity markets are certainly starting to look much better in terms of what may lie ahead.

For portfolio positioning right now, within our portfolios, we do remain conservatively position. Volatility likely had do feel better about bonds moving forward. So we have generally if we have room we are adding back to bond allocations in our portfolios. Equities, again, probably need a little bit more sign on, well, inflation really subsiding, we got a very, very incremental decline from 8.5, headlined 8.3, which was a little bit above what consensus wanted to see. So as that plays out, you know, we'll be looking to get more and more aggressive as that inflation picture starts to become a little bit more clear in our eyes.

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