First quarter of 2022 scrambled predictions

“Things Always Become Obvious After the Fact” – Nicholas Nassim Talib, Essayist, Statistician

Forecasts are an important part of our daily lives. We leave the house early in anticipation of slushy conditions on the morning commute. We put our winter jackets in storage in anticipation warmer weather – and sometimes we take them out again. But we can’t anticipate everything. The first quarter of 2022 contained some surprises in financial markets.

We started the quarter on Jan. 1 cautiously optimistic on the global economic growth picture and the stock market for the year ahead. At that time, we forecast that the U.S. economy would grow well above average (3.5% for the year) and that we would see three or four interest rate hikes, which the Federal Reserve uses as a tool to cool inflation. We were optimistic on the strength of the consumer and the strong job market, and we felt there was a solid chance inflation would taper toward the end of the year to more normalized levels (4%) as supply chain issues eased. Our caution in the face of these positive conditions came from high stock market valuations that had already priced in positive expectations.

Interest rate and bond turbulence

Early in the quarter, the Federal Reserve Board surprised most investors by pivoting to a more “hawkish” stance on interest rates, indicating that the Board may raise rates as many as seven times in 2022.¹ In response, the bond market, rapidly adjusting for higher rates, had one of their worst starts to the year in decades.

Since we forecasted rising rates, we had positioned bonds in portfolios defensively and increased bond alternatives, as suitable. These strategies worked, resulting in declines generally lower than that of key bond indices, including the Bloomberg Aggregate U.S. Bond Index.

Inflation and growth shifts

With the tragic war and humanitarian crisis in Ukraine, we are dealing with new inflation pressures, especially in oil and gas. Rather than cooling off, inflation accelerated at a decades-high pace. As a result, higher prices will likely linger over the year instead of dispersing in the latter part of the year, which is an increased risk for markets, consumers, and companies.

We expected inflation to be a catchword in 2022, but few, including us, forecasted the large shift in prices we are experiencing. Largely due to the war, we have seen expectations for U.S. economic growth moderate from an exceptional 4% to a closer-to-average 2.8%.^2,3 Global growth is also expected to moderate.⁴ Consumer expectations have shifted negative over the course of the quarter, while job growth and the strength of the labor market has continued to beat expectations.⁵

Stocks sell-off and partially recover

Rapid shifts in interest rates, the Ukraine invasion, and inflation expectations whipsawed the stock market this quarter. The S&P 500⁶ dropped from an all-time high at the beginning of January to down 14% on the day of the invasion of Ukraine – then recovering to just below 6% off the all-time high by the end of the quarter. What happened? At the beginning of the quarter, the price of fast-growing stocks retreated as interest rates jumped up (fast-growing stocks generally become more expensive to own when rates rise). Stocks that are more insulated against rising rates and inflation fared much better over the course of the quarter (“value” or defensive stocks).

International markets followed a similar path, responding to additional risks of the war in Ukraine, COVID lockdowns in China, and energy risks in Europe. Historically, stocks have ended up in positive territory after a geopolitical shock event.⁷ We’ve seen stocks rally partially already, digesting new information about higher prices and higher interest rates. Growth in company profitability drives the stock market — and estimates for U.S. stock earnings actually moved higher during the quarter, though 2022 will likely not be a banner year for profits like 2021.^8-11 We didn’t expect the hairpin turn in the stock market this quarter, but over the past six months we had been moving, as suitable, towards increasing defensive, quality stock tools, which can help add cushion during times of volatility.

Looking ahead

We wrote in March about our thoughts on the Ukrainian war and inflation – and portfolio adjustments we have made, as suitable. In the face of very difficult world events and their financial implications, it is easy to move to a negative economic/world outlook. However, our outlook over the coming 12 to 24 months, assuming the Ukrainian war does not expand, is modestly positive.

In the U.S., both companies and consumers have historically strong balance sheets (meaning, cash to spend). Consumer spending on goods is starting to moderate but spending on services is accelerating, with consumers anxious to take vacations and resume gatherings.¹²

Higher inflation for longer is likely, although it will also likely moderate as additional energy resources come on line. While we’ve included direct inflation hedges in portfolios, as suitable, it is important to keep in mind that stocks themselves are an inflation hedge as they increase prices to keep up with inflation, and therefore, increase their stock price.

Please let us know your questions and comments. It is always a pleasure to hear from you.

Index definitions

Bloomberg U.S. Aggregate Bond Market Index: A representation of SEC-registered, taxable, and dollar denominated securities. The index covers the U.S. investment grade fixed rate bond market, with index components for asset-backed securities, government and corporate securities, and mortgage pass-through securities. Must be rated investment grade (Baa3/BBB- or higher) by at least two of the following rating agencies: Moody’s, S&P, Fitch; regardless of call features have at least one year to final maturity and have an outstanding par value amount of at least $250 million.

Bloomberg U.S. Municipal Bond Market Index: Covers the USD-denominated long-term tax-exempt bond market. The index has four main sectors: state and local general obligation bonds, revenue bonds, insured bonds and pre-refunded bonds.

S&P 500 Composite: Representing approximately 80% of the investable U.S. equity market, the S&P 500 measures changes in stock market conditions based on the average performance of 500 widely held common stocks. It is a market-weighted index calculated on a total return basis with dividend reinvested.

Russell 1000 Growth Index: Russell 1000® Growth Index measures the performance of the large cap growth segment of the US equity universe. It includes those Russell 1000 companies with higher price-to-book ratios and higher forecasted growth values. The Russell 1000 Growth Index is constructed to provide a comprehensive and unbiased barometer for the large-cap growth segment. The index is completely reconstituted annually to ensure new and growing equities are included and that the represented companies continue to reflect growth characteristics.

Russell 1000 Value Index: The Russell 1000® Value Index measures the performance of the large cap value segment of the US equity universe. It includes those Russell 1000 companies with lower price-to-book ratios and lower expected growth values. The Russell 1000 Value Index is constructed to provide a comprehensive and unbiased barometer for the large-cap value segment. The index is completely reconstituted annually to ensure new and growing equities are included and that the represented companies continue to reflect growth characteristics. 

Russell 2000 Index: The index measures the performance of the small-cap segment of the US equity universe. It is a subset of the Russell 3000 and includes approximately 2000 of the smallest securities based on a combination of their market cap and current index membership.

MSCI EAFE (Europe, Australasia, Far East) Index: A free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada. As of June 2, 2014, the index consists of 21 developed market country indices: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, and the United Kingdom.

MSCI Emerging Markets (EM) Index: A free-floating index offered by Morgan Stanley that captures mid and large capitalization stocks across more 26 countries including many in S. America, Eastern Europe, Africa, the Middle East, and parts of Asia, including Indonesia, the Philippines, and Taiwan.

Sources and notes

1. Not All Yield Curve Inversions Are Fatal
2. The Fed lowered its US economic growth forecast in the face of war and inflation
3. Economic Forecast for the US Economy
4. IMF World Economic Outlook Update January 2022
5. March Jobs Report/
6. See Index Definitions
7. The resilience of markets through dark times
8. Multi-Asset Solutions Monthly Strategy Report
9. After a Quarter for the Record Books, What’s Next?
10. Wall Street forecasts for US stock returns for the end-of-year are quite disparate and in a different place than when investors started the year (source FactSet Data).
11. After a Quarter for the Record Books, What’s Next?
12. ‘Real’ Spending By Americans Dips To Second Highest Ever

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