Mercer’s Second Quarter 2022 Market Review

as of June 30, 2022

High inflation, an increasingly hawkish Federal Reserve and economic uncertainty weighed on markets during the second quarter. Global equities reached bear market territory, with the MSCI ACWI Index, a measure of the global equity market, down 20% year-to-date through June. The simultaneous decline in bonds has made this year particularly painful for balanced portfolios. US inflation continued to move higher in Q2, and the Federal Reserve has responded with an accelerated pace of tightening.  It remains to be seen whether the Fed’s actions can slow inflation without causing a recession. Additionally, the Russian invasion of Ukraine continues to cause commodity supply disruptions and economic uncertainty, adding to the challenges central bankers face.

The growth outlook has become more uncertain as persistent inflation has pushed central banks to tighten more aggressively.  Consensus growth forecasts have moved lower for both 2022 and 2023. Manufacturing Purchasing Managers Index (PMIs) barely remain in expansionary territory for most developed markets now, having trended downward in 2022.  China’s PMI has rebounded as COVID restrictions eased in the second quarter. While downside risks have increased, the labor market continues to show strength.  The US unemployment rate has fallen to 3.6% after peaking at 14.7% in April 2020. The labor force participation rate remains roughly one percentage point below its pre-COVID level.

Global equities posted steep declines in the second quarter amid tightening monetary policy, with the MSCI ACWI index falling 15.7% for the quarter.  Year-to-date, the index has declined 20.2%. The S&P 500 fell 16.1% during the quarter, and is now down 20.0% year-to-date. International developed stocks declined 14.5% in Q2, leaving its year-to-date decline at 19.6%. Emerging market equities fell 11.4% in Q2 and 17.6% year-to-date.  Asian emerging markets were the best performing region during the quarter as Chinese equities posted modest gains, while Latin American emerging markets struggled.

Within fixed income rising interest rates weighed on returns. The Bloomberg Aggregate declined 4.7% during the quarter.  Treasuries declined 3.8%, but outperformed corporate bonds, which declined 7.3%. The yield curve shifted higher and flattened, with one-year yields rising 117 basis points, while 30-year yields rose by 70 basis points.

REITs fell roughly 17% during the quarter, in line with the declines in broader equity markets.  Infrastructure stocks held up relatively well both in the second quarter and 2022 as a whole, down 4% year-to-date.  Commodities and natural resource stocks declined on fears that a potential recession could cause a slowdown in demand.  However, returns for these assets remain strong year-to-date as supply concerns drove large gains early in the year.

Market behavior this year appears to be a mostly rational response to the increase in longer-term interest rates, along with the rise in economic uncertainty from inflationary pressures, Ukraine-Russia conflict, Chinese lockdowns and policy tightening. Our base case view is that the monetary policy response priced by markets should curb inflation with only an economic slowdown or a mild recession. However, the risk of downside scenarios has increased. Should Fed tightening prove too much for the heavily-indebted US economy to bear, inflationary fears could give way to fears of a deeper recession. However, interest rates could decline in this scenario, providing some cushion to balanced portfolios. A more worrisome outcome is that inflationary pressures stay high even as economic growth slows, requiring the Fed to respond even more forcefully. We expect this would be negative for stocks and bonds.

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