After an exceptional 2021, the first half of 2022 was both emotional and difficult. Russia’s invasion of Ukraine, soaring inflation and the start of the Fed’s rate hike cycle weighed on stocks and bonds, while commodities boomed. Here are ten stories worth remembering from the tumultuous first half.
Charles-Henri Monchaux, IT Director, and Valerie Noel, Head of Commerce
1 – Invasion of Ukraine
This is undoubtedly the most dramatic and significant event of the first half of 2022. Although a Russian invasion of Ukraine seemed likely at the beginning of the year, Russian President Vladimir Putin’s decision to wage a full-scale war outside the separatist region of Donbas stunned the world. In addition to the human tragedy of the conflict, the sanctions imposed by the West have serious consequences for the economy and the global monetary order.
This episode in history occurred at a time when the supply of raw materials was no longer sufficient to meet demand. However, Russia extracts and exports the vast majority of them: oil, natural gas, industrial metals, precious metals and agricultural raw materials. Thus, the global economy faces a shock in the supply of raw materials, with implications for both growth (downside risk) and inflation (upside risk). At the time of writing, a quick end to the war, and hence the imposition of sanctions, seems unlikely. Even if an agreement is reached, normalization of relations between Russia and the West could take years as long as President Putin remains in power.
2 – Inflation jumps as growth slows
Inflation continues to surprise on the upside, hitting multi-decade highs around the world. In April, the U.S. consumer price index jumped 8.5% from a year earlier to a 40-year high, driven by rising prices for gasoline, food and housing. The United States continues to face high rent and wage inflation. In Europe, inflation in Germany accelerated to 7.9% year-on-year in May, the highest level since monthly statistics were first calculated in 1963. If the immediate impact of the conflict on the global economy is to be limited (the Russian economy represents less than 2% of global GDP), rising commodity prices may contribute to higher or at least more sustainable inflation. China’s Covid-related sanctions and quarantines could lead to new bottlenecks in the supply chain.
3 – The end of easy money
On March 16, the Fed’s FOMC raised interest rates for the first time since December 2018. Although Chairman Jerome Powell initially called post-vaccination inflationary pressures “transient,” Fed officials disagree. During the first half of the year, they signaled their intention to raise rates multiple times, as well as reduce the size of the Fed’s balance sheet. As expected, the Fed hiked another 50 basis points (bp) in May, and the market expects another 50 bp hike. at each of the next two FOMC meetings in June and July.
Meanwhile, investors adjusted their expectations accordingly, pricing in a fast and sharp cycle of rate hikes in the short term, with potentially negative implications for growth and therefore rates going forward. The European Central Bank (ECB) will probably have no choice but to normalize its monetary policy. The market currently expects a rate hike of more than 100 basis points by the end of the year.
4 – From fear of interest rates to fear of recession
From a macroeconomic perspective, global GDP continues to grow above trend, but forecasts for 2022 have been sharply revised downwards. This caused the market to shift from fears of rates (or bond yields affecting stock valuations) to fears of a recession; indeed, rising food and energy prices are likely to dampen consumer spending, while businesses may be forced to cut hiring and spending if higher wages and energy costs affect profitability.
Economic indicators point to a sharp slowdown in growth in the US. In Europe, groups representing German employers and unions jointly opposed an immediate ban on natural gas imports from Russia, saying the move would lead to plant closures and job losses.
5 – Sustainable enterprises and consumers
Despite all the negative headlines about war and inflation, there are a few bright spots, including two areas of relative economic strength in the United States. First, US consumers remain healthy, with unemployment down to 3.6% – the lowest level since the pandemic – and average hourly wages growing at a healthy +5.5% year-over-year rate. American households entered the year with more than $2.5 trillion more in savings than before the pandemic, giving them some breathing room from rising borrowing costs. On the corporate side, balance sheets and earnings growth have been solid, and we continue to see an upward revision to our 2022 earnings outlook. Analysts typically downgrade earnings growth forecasts for the year due to events in the first quarter of 2022. But we haven’t seen it yet. The S&P 500 earnings growth forecast is now 10%, up from 7.0% at the end of 2021.
6 – Worst first half since 1970 for global stocks
The S&P 500 fell 20.6% in the first half of the year, its biggest drop since 1970. It also entered bear market territory, losing more than 21% from its all-time high reached earlier in the year. January. The Nasdaq has lost 29.5% since the start of the year, its worst start to a year on record. European shares posted the biggest half-year decline since the global financial crisis, with the Euro Stoxx 50 down 19.6% (in local currency). The MSCI Emerging Markets Index fell by -18.4% (in US dollars). Japan’s Nikkei 225 index fell 9.9% in local currency, but the Japanese yen’s decline was much worse in dollar terms. In terms of style, global value (-6.5% YTD) far outpaced global growth (-29.5%).
7 – Bond markets are not fulfilling their diversification role
Diversified multi-asset portfolios have suffered in terms of performance since the start of the year for obvious reasons. While bonds and stocks tend to have a weak or even negative correlation, the situation has been very different in recent months. Not only are most equity markets now down 15-20% year-to-date, but bonds are also posting double-digit negative returns in 2022, a record for balanced equity/bond portfolios. Indeed, the global bond market has just suffered its biggest drop in history. Since the beginning of the year, the Bloomberg Global Aggregate Bond Index has lost 13.9%. US Treasuries fell 9.1%. Government bonds in euros fell by 12.2%, and debt obligations of developing countries fell by 17.1%.
8 – Exceptional beginning of the year for goods
Commodities were the most efficient asset class in the first half of the year. At the end of May, the Bloomberg Commodity Spot Index rose by 17.9%. Oil was the standout for many, with Brent up nearly 40% in its best start to a year for oil since 1999. Natural gas prices also rose sharply after the Ukrainian invasion.
However, the results were not positive in all product segments. After a decent first quarter, industrial metals ended the period in negative territory as China’s Covid-related quarantine measures weighed on industrial activity and threatened to limit metal imports. Copper fell in price by -17.4% for the first half of the year.
Precious metals were also negative. In the first half of the year, gold fell by -1.2%, and silver by -13.4%. Meanwhile, food prices rose sharply before falling slightly in June.
9 – Big rotation
Over the past decade, the Nasdaq has significantly outperformed other major U.S. stock indexes, delivering 18% annualized returns between 2010 and 2019. Over the same period, the energy sector was one of the least efficient, growing at just 3.3% per year. between 2010 and 2019 compared to an annualized return of 13.4% for the S&P 500.
Since the beginning of 2021, the balance has completely changed. Energy ETF ($XLE) rose 82%, while QQQ (Nasdaq 100 ETF) fell -11%. As shown in the chart below, relative overperformance and underperformance are part of long-term trends. For example, between 1990 and 2000, technology stocks outperformed energy stocks. Then, between 2000 and 2008, it was the turn to dominate the energy sector. From 2008 to 2020, the trend reversed again, with technology stocks holding a strong relative lead over the energy sector. Is the increase in energy efficiency from 2021 part of a long-term trend that may continue into the current decade?
10 – Strong dollar. And the worst start of the year for cryptocurrencies
During the first half of the year, the dollar rate increased significantly. Expectations of a faster tightening of monetary policy in the United States contributed to the recovery of the currency, which rose by 9.3% in the first half of the year. Surprisingly, the Russian ruble is one of the best-performing currencies in 2022, up 17% year-to-date. The Turkish lira was the worst performer with a drop of almost -30%. The Brazilian real (+7.5%) appreciated thanks to the strength of commodity markets.
Cryptocurrencies started the year worst in their history. The general liquidation of assets, effective from November 2021, further affects the most speculative segments of the market. Cryptocurrencies have already experienced a sharp decline, which then accelerated with the fall of the stablecoin TerraUSD (UST). In the first half of the year, Bitcoin fell by almost 60%. Ethereum was worse, down 72% year-to-date. The market capitalization of all cryptocurrencies fell below the $1 trillion mark for the first time since the beginning of 2021.