The strong market downdraft that began just after the first of the year continued unabated during April, paused in May, and picked up momentum again in June. Analysts cited several factors applying downward pressure on stock prices. While the economic implications of the war in Ukraine remain unclear, it does seem likely to disrupt energy supplies, particularly in Europe. Energy is just one area in which recent price shocks have exacerbated fears of stubbornly elevated inflation. In response, Federal Reserve policymakers continued to make public statements apparently designed to set investor expectations for a rapid tightening of monetary conditions. Market participants largely interpreted these remarks as a signal that economic activity, or at least growth, may slow in coming months, and downrated stocks as a result, punishing high-growth names the most severely. And while the labor market remains unusually tight, and most corporate quarterly earnings reports were fairly good, many of those companies whose results disappointed the markets sold off sharply as well. The market ground lower, the S&P 500 ending with a return of –16.10% for the quarter. Smaller stocks fared nearly as badly: The Mid-cap 400 index returned –15.42%, and the Small-cap 600 index –14.11% [Index returns: Standard and Poors]
For the first six months of 2022, the S&P 500 returned –19.96%, its worst showing for the first half of a year in over half a century. However, as jarring as the rough sledding in the market has been so far this year, its overall effect has been roughly to reverse the gains the major stock indices had posted during 2021, and the S&P 500 index’s current level is about where it was in January of last year.
Global markets also fell, although not quite so sharply as those in the US. The MSCI EAFE international equity index returned –7.83% in local currencies. However, tightening US monetary policy and the war in Ukraine continued to drive the US dollar higher, and with unusual vigor. It rose to 135.63 yen, from 121.44 at the end of March. It also strengthened to $1.0469 against the euro and $1.2162 against the pound Sterling, from levels of $1.1093 and $1.3152, respectively, on March 31. These unusally sharp currency moves worked against US investors in foreign assets. As a result, EAFE had a return of –14.51% in US dollars. [Index returns: MSCI; currency rates: Federal Reserve H.10 release]
The Federal Reserve, both in public statements and in actions, drove interest rates sharply higher. The Federal Open Market Committee raised its federal funds rate target, a key short-term interest rate, by 1.25% during the quarter, and the Committee also initiated a program to reduce the size of its balance sheet. These two steps together represent a significant tightening of monetary conditions, and the increase in market interest rates was the logical – and almost surely intended – response. The yield on the two-year Treasury ended the quarter at 2.92%, up from just 2.28% at the end of March. The ten-year yield ended at 2.98%, up from 2.32% three months earlier. The Bloomberg Barclays US Aggregate Bond index returned –4.69% for the quarter. [Index returns: Bloomberg; bond yields: US Treasury]