Ouch.

The S&P 500^® Index just finished its worst six-month start to a year since 1970, down nearly 20 percent. Bond investors were equally treated, with returns as measured by the Bloomberg Barclays U.S. Aggregate Bond Index retreating a stunning 10.4%. If these two major indexes remain negative over the next six months, it will be the first time in history they have declined simultaneously in a calendar year. 

Fortunately, the move down in stocks is from record highs at year-end, but it does take the S&P 500^® Index back to market levels last seen in early 2021, specifically March 4, 2021.

From the beginning of 1925 and thru the year-end of 2021, an investment made in U.S. large company stocks has averaged an annualized rate of return of 10.5%. Small company stocks delivered an expected higher long-term return of 12.1%.  Along that 97-year journey, many periods have required patience and perseverance, such as the one we are in right now.  Surprising to many, the U.S. market typically corrects by more than 5 percent every eight months and more than 10 percent every two years. The average period to recover from these events is one month and three months, respectively. True bear markets with 20-40 percent declines occur on average every eight years and generally take fifteen months to recover.    

The current factors causing this sudden repricing of risk assets are many and some substantial.  With Covid’s health affects appearing to finally be on the wane, the best intended governmental actions have created very choppy economic waters.  Excessive money supply intended to stabilize during lockdowns, coupled with supply chain disruptions now exacerbated by war in Europe, have triggered inflation to levels not seen in decades.   Reversing these inflationary pressures is now the Federal Reserve’s top priority, and increasing interest rates is their primary tool.

Rising rates and the expectations for further increases are beginning to impact economic activity.  Recent data from some Federal Reserve District Banks suggest slowing, even recessionary, activity.  The Conference Board’s U.S. Leading Economic Index is at positive levels but has recently turned lower, while consumer sentiment, obviously reflecting higher prices, is at extremely low levels.  In addition, despite positive hiring intentions by small businesses and a very low unemployment rate, the NFIB Small Business Optimism Index is declining. 

These indicators and others suggest slowing economic activity, which could lead to lower or even negative corporate earnings growth. Conversely, this could lead to the realization of the Fed’s goal of lessening inflationary pressures, which would allow them to end their rate hiking cycle earlier and at a lower level than anticipated.  Vigorously debated is whether the Fed can guide the economy through a soft landing or if a harder recession will be realized.  

All of this uncertainty has created nervousness and in turn volatility for marketable assets.   We believe the Federal Reserve will ultimately be effective in containing inflation, but the open question is how long this will take.  Markets will likely prove to be strongly forward-looking and investor attempts to take a sideline stance to wait for economic indications in an effort to predict a market bottom, we believe will once again be shown to be “fool’s folly”. 

We remain focused for you on the ongoing active management of your assets rooted in the construction of a portfolio of high-quality companies with solid management teams, pricing power, and financial strength to succeed through full economic cycles and in these challenging inflationary times. We have slightly increased cash levels in most accounts to be a bit more defensive and opportunistic if markets correct further, before recovering.  We have also adjusted exposures, increasing investments in recessionary resilient sectors such as healthcare and consumer staples.  

The volatility we are experiencing is presenting opportunities for future returns. We are diligently seeking to capitalize on these for you, our valued clients, and remain confident in our proven long-term strategies. 

Thank you and enjoy your summer.

Sincerely,

Peter J. Connors, CFA

President

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