Wow, where do I start? Perhaps with raging inflation not seen since the early 1980s, partisan government dysfunction or Russia invading Ukraine?  If you feel like I’m repeating myself, I am.  This was the first sentence from my commentary after the first quarter of 2022. All three of those factors that affected both the economy and the national mood grew worse during the second quarter.  Inflation continued to accelerate prompting the Federal reserve to hike interest rates by 0.75% in June, the largest single meeting increase in nearly 30 years.  The Russia-Ukraine conflict appears likely to be a longer-term conflict than originally thought, or perhaps hoped, and the January 6^th hearings and recent Supreme Court decisions seemed to widen the partisan chasm. The S&P 500 hit bear market territory (down over 20% from recent highs) and the Nasdaq was down over 30% from its high reached in November 2021. It is the worst first half performance in over 50 years.

Usually during bear markets, there are bear market rallies and we had small ones during March and May, but the downdraft has seemed relentless.  The most recent bear markets, in the 4^th quarter of 2018 and first quarter of 2020 (Covid) has quick recoveries.  Those were due to issues the market felt could be dealt with by monetary or fiscal policy, but the current crop of issues seems to be beyond the control of policymakers at least in the near-term. While I’m not sure at what level the market bottom will be (or whether we have already hit it) or when it will come, meaningful progress on inflation will have to be made before the markets can recover a substantial chunk of their losses.

There has been a significant reduction in consumer confidence, which has been in no small part caused by high inflation, wealth destruction from stock market losses (checked your 401K lately?), as well as higher financing costs as 30-year mortgages neared 6% last quarter. Together, these have and will continue to reduce consumer demand, especially for housing and discretionary good and services.  Demand is one side of the supply-demand disequilibrium responsible for the current bout of inflation. The resolution of supply side issues is more unpredictable as they are in large part dependent on China’s Covid policy and the Russia-Ukraine conflict. Commodity prices, like metals, lumber and agricultural inputs have all come down dramatically in recent months and even oil prices have dropped in the last few weeks. Mortgage applications and housing starts also declined precipitously in May after having been quite strong through April.  Hopefully we will start to see the inflationary pressures ease over the balance of the year, although I expect it will be well above normal for at least the next year.

Value stocks continued to outperform growth stocks during the second quarter as higher interest rates have a more profound effect on companies with no or low current earnings.  That said, the best performing sectors during the second quarter, utilities, energy, consumer staples and healthcare were all down 4% to 6%, so there was nowhere to hide.  Communication services and consumer discretionary were down over 20% and all 5 other sectors lost between 14% and 20% during the quarter.  Absolutely abysmal.

Bond markets continued their slide during the second quarter and have had the worst 6 month start to a year since records have been kept as increasing rates and the prospect of continued Federal Funds Rate increases led to higher yields and lower prices as bond prices move inversely to yields. The AGG ETF, which holds investment grade government, agency and corporate debt was down over 10% for the year through June 30^th.  The selloff has led to yields on investment grade corporate bonds that are now more attractive than I’ve seen in years. One major caveat is that should the economy slide into recession, the risk of individual bond issue defaults increases so bonds must be selected carefully.

Hopefully the saying that it is always darkest before the dawn will hold true.

One piece of housekeeping: I moved my offices across the street to 4 East Main Street, Suite B, Cambridge NY 12816.  For locals, it is the beautiful historically renovated Agway building next to the Cambridge Food Cooperative.  Please stop by if you are in the neighborhood.

I hope you are all well and enjoying the summer. Should you have any questions about the attached report, this email, your portfolio, or anything else related to your financial life, my line is always open.

Best regards,

Steve