Global financial markets continued to sell off in the second quarter, with virtually all asset categories in the red. Global markets suffered their worst quarter since the pandemic lows in the first quarter of 2020. Market volatility continued to be a major talking point throughout the second quarter. Driving factors behind the volatility were the Federal Reserve’s hawkish stance on inflation that continued to persist in the second quarter and quantitative tightening to slow down the economy.
All major market indices continued to contract during the quarter. Equity markets, as measured by the S&P 500 Index, fell by 16% with the median stock in the index falling by 40%.
With inflation persisting during the quarter, long term interest rates continued to surge. The 10-year U.S. Treasury started the quarter on April 1st at 2.39% and subsequently finished the quarter at 3%. The significant move in the bond market also contributed to volatility in the stock market, with all S&P 500 sectors finishing in negative territory.
A trend that persisted during the second quarter was the outperformance of large cap stocks relative to small and mid-cap with investors looking for higher quality, lower beta names during uncertain times. By investment style, value stocks continued to outperform their growth counterparts with several of the value sectors such as energy, utilities, and consumer staples leading the market. Value indices still sit below historic forward P/E levels as measured by the Russell 1000 Value Index, which currently has a forward P/E of 12.76x compared to its long-term historical average of 14.10x.
A major theme outside the U.S. was the outperformance of Chinese equities, mainly due to the Chinese Central Bank taking a much more dovish approach, cutting rates compared to other global central banks that are currently hiking rates aggressively to try to curb inflation. During the quarter the MSCI China Index gained 3.4% compared to the MSCI ACWI Ex USA Index that declined 13.5%.
Interest rate volatility continued during the quarter at both the short and long end of the yield curve. Yields of 2-, 10-, and 30-year Treasuries all increased, with the 30-year Treasury in particular gaining 0.74% during the quarter and 1.37% on a year-to-date basis. As a result of the significant rise in rates and investors’ low appetite for risk, the dollar index saw new highs during the second quarter, hitting a 19-year high of $104.70. A strong dollar means U.S. exports are more expensive overseas which could drive down demand for goods produced domestically; however, a strong dollar can benefit U.S. travelers overseas and U.S.-based consumers purchasing foreign goods.
The U.S. economy contracted during the second quarter by -0.9%, which was the second straight quarter of negative real economic growth. The U.S. economy continues to be hindered by relentless inflation, causing an unpleasant stagflationary environment, and persistent supply-chain bottlenecks.
Despite the negative economic growth, the labor market remained particularly strong. In the second quarter, 1.19 million jobs were added to the U.S. economy, with education and health services leading the way. The overall U.S. unemployment rate of 3.6% remains at historically low levels with the total number of unemployed people standing at 5.9 million.
Inflation, as measured by the Consumer Price Index (CPI-U), grew at a pace of 9.1% for the past 12-month period ending June 30, 2022. The core inflation reading, which excludes food and energy, rose 5.9%. The energy index in particualr rose 41.6% over the last year, the largest 12-month increase since the period ending April 1980. The food index increased 10.4% for the 12-months ending in June, the largest 12-month increase since the period ending February 1981.
Despite the elevated inflation levels, consumer finances remain relatively strong as of June 30, 2022. Debt payments as a percentage of disposable income are still relatively low at 9.5%, compared to past times of adversity, such as the fourth quarter 2007 when debt payments as a percentage of disposable personal income hit 13.2%. However, the personal savings rate has slowed considerably and credit card utilization has been on the rise, demonstrating consumers are feeling the impacts of higher prices across the economy.