as of March 31, 2022
Russia’s invasion of Ukraine has heightened tensions around the globe. The human impact has been devastating and the risk of escalation remains. While markets have remained relatively calm to date, the supply shock to energy and other commodities raises downside economic risks. The war’s impact on food inputs also risks spilling over and creating unrest in other parts of the world. In addition, COVID related lockdowns in China have weighed on output and sentiment, adding to global supply chain constraints.
The labor market remains strong and is likely nearing full employment. This has contributed to wage increases, and is supporting consumer spending. While demand for goods remains strong and firms have been able to maintain healthy margins, there is likely a point where continued rising prices would begin to weigh on economic activity. At its March meeting, the Federal Reserve raised interest rates by 25 basis points and in subsequent comments, Fed officials have signaled increasingly hawkish views. The market has priced a Fed Funds interest rate of nearly 3% by the end of 2022.
Global equities declined in the first quarter, with the MSCI ACWI index, a measure of global equities, falling 5.4% for the quarter. Over the past one-year, the index was up 7.3%. The S&P 500 index fell 4.6% during the quarter, but held up better than most other regions. The S&P 500 index returned 15.6% over the past year. International developed stocks declined 5.9%, reducing the one-year gain to 1.2%. A stronger dollar detracted 2.2% from US dollar returns during the quarter. Emerging market equities fell 7.0% in the first quarter and were down 11.4% over the past year.
Within fixed income, the Bloomberg Aggregate index declined 5.9% during the quarter. Treasuries declined 5.6%, but outperformed corporate bonds, which declined 7.7%. The yield curve flattened during the quarter, with two-year yields rising 155 basis points, while 30-year yields rose by 54 basis points.
Infrastructure stocks outperformed broader markets for the quarter, but lagged over the course of the past year. REITs declined roughly 4% during the quarter, but outperformed broader equity markets. REITs have broadly benefited from reduced COVID restrictions, but could face challenges in a rising rate environment. Commodities spiked as investors became concerned with supply disruptions and sanctions following Russia’s invasion of Ukraine.
Mercer expects the global economy to continue to expand over the short-term. However, the risk of a recession could rise late this year and into 2023 as financial conditions tighten. This makes us more cautious on the outlook for equities and other growth assets. The Federal Reserve seems committed to bringing inflation down. The market has already priced in significant interest rate tightening, which should allow the Fed some room to maneuver, if needed. However, an aggressive pace of tightening could weigh on equity valuations and increase the odds of a recession over the intermediate-term. Finally, political risks became increasingly prevalent throughout the quarter and could lead to additional volatility and downside risk.
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