Investment Outlook Q2, 2022

Q2 2022

INVESTMENT OUTLOOK

April 19

DBFitzpatrick

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INVESTMENT OUTLOOK | Q2 2022

INSIDE THIS ISSUE:

The U.S. Federal Reserve Plays Catch-Up

3-5

Equities Adjust To A New Rate Regime

5-6

DB Fitzpatrick 800 W. Main Street, Suite 1200 Boise, Idaho 83702 (208) 342-2280 www.dbfitzpatrick.com

3

THE U.S. FEDERAL RESERVE PLAYS CATCH-UP Inflation was elevated during the

It’s now clear that the Federal

first quarter, putting significant

Reserve was late to begin this

pressure on U.S. Federal Reserve

monetary tightening cycle and

The persistence of inflationary

(Fed) policymakers to tighten

policymakers have been working

pressures and consequent

monetary policy. The Consumer

to assure investors that they will

increasingly hawkish tone of Fed

Price Index was 7.9% in its latest

keep inflation within reasonable

policymakers jolted the bond

reading, with inflation breakeven

bounds. As a start, the Fed raised

market in the first quarter, with

rates (what investors expect

the fed funds rate by 25 basis

investors today pricing in

inflation to be in the future) also

points in March and various Fed

expectations for a further 2.00%

up significantly in recent months.

governors have signaled that

increase to the fed funds rate by

Aggregate demand has been

several more rate hikes are coming year-end. Since there are six FOMC

strong, with consumer spending

throughout the remainder of 2022. (Federal Open Market Committee)

up as the most severe waves of the Additionally, the Fed has

at policymakers’ disposal.

meetings remaining this year, this

pandemic appear to be over.

announced plans to wind down its means that the bond market is

Aggregate supply has been the

sizable balance sheet (which

currently expecting rate hikes of at

bigger factor pushing inflation,

mainly consists of U.S. Treasuries

least 25 basis points at each

however, with the continued

and agency mortgage-backed

meeting, with 50 basis point

impact of COVID-19 around the

securities), another important tool increases at two of those

world bogging down supply chains. The war in Ukraine was an additional factor

U.S. Inflation Breakeven Rates

contributing to elevated inflation late in the first quarter, as the conflict led to a jump in commodity prices.

Source: Bloomberg

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INVESTMENT OUTLOOK | Q2 2022

meetings. This represents a high number of interest rate hikes incorporated into today’s bond prices, and a big jump from what was expected early in the first quarter.

In response to increased hawkishness at the Fed,

U.S. Treasury Yield Curve

the U.S. Treasury yield curve has risen sharply, with the biggest move on the short end of the curve.

Source: Bloomberg

Short duration bonds have outperformed longer duration bonds this year due to lower sensitivity to

flat between the 3 and 10-year tenors, signaling bond

changing interest rates. The Merrill Lynch 1-3 Year

investors’ belief that the U.S. economy could slow in

U.S. Treasury Index returned -2.3% during the first

the medium term. Ironically, an overly hawkish

quarter, while the Bloomberg U.S. Long Treasury

Federal Reserve could prove to be a positive for

Bond Index returned -10.6%. Intermediate duration

some areas of the bond market, as restrictive

indexes were between these two extremes, with the monetary policy could lead to lower longer-term Bloomberg U.S. Mortgage-Backed Security and

interest rates. We believe there is a significant risk of

Bloomberg U.S. Aggregate Bond indexes returning

this occurring during the next year or so and that the

-5.0% and -5.9%, respectively, during the quarter.

bond market offers attractive opportunities at current levels.

The recent hawkish turn among Fed policymakers risks overshoot, with the bond market clearly

Bond yields are as high as they’ve been in several

flashing signs of worry about monetary policy error.

years and are especially attractive in the intermediate

For example, the U.S. Treasury yield curve is quite

and short duration spaces. The Bloomberg Barclays

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Mortgage-Backed Security Index

indexes, the Merrill Lynch 1-3 Year

higher yields will be beneficial for

has a yield of 3.5% today, up from

U.S. Treasury Index today has a

investors with a longer investment

2.0% at the end of December.

yield of 2.4%. Despite the negative horizon.

Among short duration bond

returns of the first quarter, these

EQUITIES ADJUST TO A NEW RATE REGIME The MSCI All Country World Index (ACWI), a measure The war in Ukraine further dampened investors’ of the global stock market, returned -5.3% during the

mood midway through the quarter, but as horrifying

first quarter. Energy, financial, and other “value”

as the events in Ukraine have proven to be, the

stocks (defined as those with lower valuations and

broad equity market has much more exposure to in-

lower growth prospects over the longer term) out-

terest rates than it has to the war.

performed “growth” stocks and the broader market.

While there was heightened deviation in sector-level

Additional volatility may lie ahead for equities. Inves-

returns this quarter, the ACWI's performance em-

tors are jittery today with the war in Ukraine unre-

blematized the elevated market volatility. The global solved and it is not yet clear when inflation will peak. benchmark was down nearly 13% for the quarter at its Things look more positive for the medium and longer trough in early March, before recovering 8% by the

term, as it’s likely that inflation will eventually fall as

end of the month.

monetary policymakers aggressively target it and as constraints to aggregate supply diminish. The timing

Macroeconomic fac-

U.S. Equity Returns

tors have been driv-

ing the equity market. Elevated inflation and higher interest rates are the biggest of these, with higher U.S. Treasury yields resulting in higher discount

rates for equities.

Source: Bloomberg

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INVESTMENT OUTLOOK | Q2 2022

of equity market movements in the short run is very difficult to predict, of course, but when the market begins to discount the

prospect for improvement in the macro environment, long-term investors will want to be

Chicago Board Options Exchange Volatility Index (VIX) Source: Bloomberg

fully invested. Market recoveries often occur very suddenly and forcefully.

the technology sector which, after the volatility of the first quarter, has areas that are attractive today.

Our equity portfolios hold overweight positions to the industrial, materials, and healthcare sectors, and underweight positions to the financial, energy, and consumer staple sectors. We are roughly neutral on

— Brandon Fitzpatrick, CFA

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THIS PUBLICATION IS FOR INFORMATIONAL PURPOSES ONLY. THIS PUBLICATION IS IN NO WAY A SOLICITATION OR OFFER TO SELL SECURITIES OR INVESTMENT ADVISORY SERVICES, EXCEPT WHERE APPLICABLE, IN STATES WHERE DB FITZPATRICK IS REGISTERED OR WHERE AN EXEMPTION OR EXCLUSION FROM SUCH REGISTRATION EXISTS. INFORMATION THROUGHOUT THIS PUBLICATION, WHETHER STOCK QUOTES, CHARTS, ARTICLES, OR ANY OTHER STATEMENT OR STATEMENTS REGARDING MARKET OR OTHER FINANCIAL INFORMATION, IS OBTAINED FROM SOURCES WHICH WE AND OUR SUPPLIERS BELIEVE RELIABLE, BUT WE DO NOT WARRANT OR GUARANTEE THE TIMELINESS OR ACCURACY OF THIS INFORMATION. BLOOMBERG FINANCE L.P. IS THE SOURCE UTILIZED FOR GRAPHS THROUGHOUT THIS PUBLICATION. THE GRAPHS ARE USED WITH PERMISSION OF BLOOMBERG FINANCE L.P. NEITHER WE NOR OUR INFORMATION PROVIDERS SHALL BE LIABLE FOR ANY ERRORS OR INACCURACIES, REGARDLESS OF CAUSE, OR THE LACK OF TIMELINESS OF, OR FOR ANY DELAY OR INTERRUPTION IN THE TRANSMISSION THEREOF TO THE USER. THERE ARE NO WARRANTIES, EXPRESSED OR IMPLIED, AS TO ACCURACY, COMPLETENESS, OR RESULTS OBTAINED FROM ANY INFORMATION CONTAINED IN THIS PUBLICATION. NOTHING IN THIS PUBLICATION SHOULD BE INTERPRETED TO STATE OR IMPLY THAT PAST RESULTS ARE AN INDICATION OF FUTURE PERFORMANCE.

DB Fitzpatrick 800 W. Main Street, Suite 1200 Boise, Idaho 83702 www.dbfitzpatrick.com | (208) 342-2280