Equities were volatile in Q1 as markets grappled with an uneven global expansion, inflation caused by both COVID-19 supply-chain issues and commodity shortages due to the war in Ukraine, and an increasingly hawkish stance from the Federal Reserve that sent bond markets lower in price, higher in yield, and at a more rapid pace than expected.

Risk assets have repriced lower, and while the global economy may have passed its peak rate of growth, the constructive economic backdrop is expected to continue during 2022.

Market and Economic Trends

An overview of how changing markets could impact your investments follows.

Labor Markets

Labor force participation has stabilized as the strong job market drew people back into the workforce.

Worker shortages are expected to decrease as more employees return to work. However, some of the 2.5 million people who left the labor force during the pandemic—especially older workers—might not return, which could allow some of the supply-demand gap to persist.

Corporate Earnings

The nearly 50% rebound in corporate earnings during 2021 far exceeded expectations amid accelerating sales growth and greater corporate pricing power.

With profit margins back to all-time highs and having already outpaced typical midcycle gains—and facing unusually high wage pressures—it may prove more challenging to expand them going forward. Expect slower, but still solid, high single-digit profit growth in 2022.

Inflation

Inflation is the main wild card in 2022. Base-year effects should help reduce inflation rates from the current 30-year highs, but categories where price changes tend to be stickier, such as housing and food, now account for a larger portion of inflationary pressure.

Though market expectations for inflation in the near term remain well above pre-pandemic levels, longer term indicators show that inflation pressures are expected to abate in the coming years.

In the past, when inflation and interest rates have risen from extremely low levels, stocks generally have done well in a robust economic recovery.

Fiscal and Monetary Impacts

Fiscal

After nearly $3 trillion of emergency stimulus in the US during fiscal year 2021, the federal budget deficit is set to shrink and offer less fiscal support in 2022.

Legislation approved in Q4 provides more than half a trillion dollars of extra multiyear spending on infrastructure, which traditionally has a high multiplier effect on near-term growth. Any additional multiyear spending will depend on congressional negotiations this year.

Monetary

Trillions of dollars of asset purchases by global central banks in 2021 resulted in abundant financial market liquidity, supporting asset prices, and subduing volatility.

However, global monetary policy has shifted primarily toward removing accommodation, thus creating potential headwinds for both stocks and bonds in the short term.

Global Bonds

The war in Ukraine, and the resulting humanitarian crisis that continue to unfold, dominated the headlines in Q1. While there was a short-lived rotation toward safe-haven assets like bonds as the war began, investors quickly focused on the inflationary pressures brought on by the invasion, exacerbating existing concerns about commodity prices, particularly food and energy.

Bonds sold off in price and yields rose sharply. Central banks turned surprisingly hawkish, and markets priced at a faster pace of monetary normalization. The extent of yield moves differed across markets, but the US Treasury market is in the midst of one of its worst corrections on record.

The Federal Reserve’s rhetoric turned more hawkish, and liftoff came as expected in March with the implementation of a 25-basis point rate hike. Investors expect several more rate hikes at a swift pace in 2022. The US 10-year Treasury yield increased from 1.51% to 2.35% by quarter end, with the two-year yield rising from 0.73% to 2.33%.

Leading Indicators

Leading indicators have been constructive. While the indicator measuring the gap between new-order demand and the supply of inventories remained positive over the quarter, it did shrink adding a potential headwind for the markets. The Purchasing Managers Index (PMI), which serves as a useful leading indicator of economic activity, remained firmly at expansionary levels.

The US Consumer

The US consumer is supported by record-high net worth, pent-up savings, and strong employment markets. While sentiment has declined due to high inflation and geopolitical unrest, consumption is expected to be strong in coming quarters, in particular in the area of services.

Outlook

It’s been a challenging time in the markets with many risks and uncertainties. Nonetheless, optimism toward the economy holds fast with growth expected to remain above trend. At the same time, a disciplined approach to managing portfolio risk is recommended.

Diversification and Long-Term View

A strong strategy to achieve long-term success is to remain in the market with a diversified asset allocation that’s appropriate for your specific risk tolerance, objectives, and time horizon.

A long-term plan with a diversified portfolio consisting of equities in both the United States and abroad—with a mix of size and style, including lower volatility strategies like bonds, hedged equity, and defensive sectors like utilities—can cushion the inevitable bear markets in the long term.

While market downturns can be unsettling, they’re part of the investing process. Some risks always remain, but macroeconomic fundamentals remain strong for the long term. It’s important to remember that a well-executed and diversified, long-term financial plan can overcome bouts of volatility.

We’re Here to Help

For personalized insight or if you have questions about how changing markets could impact you, please reach out to your Moss Adams advisor.

You can also find more insights on our Private Clients page.