Quarter 2, 2022 Market Commentary

• Published on July 11th, 2022

Quarter 2, 2022 Market Commentary

Past performance is not indicative of future results. The information mentioned is for illustrative purposes and should not be considered a recommendation to buy or sell.

Both shares and bonds were under pressure in the second quarter as investors anticipated further interest rate hikes and an increased risk of recession. Inflation continued to rise in many major economies. Among equities, the MSCI Value index outperformed its growth counterpart, though both saw sharp declines. Chinese shares were a bright spot as prolonged lockdowns were lifted in some major cities.

Please note that any past performance mentioned is not a guide to future performance and may not be repeated. The sectors, securities, regions, and countries shown are for illustrative purposes only and are not to be considered recommendations to buy or sell.

US

US equities declined in Q2 as investors focused on inflation and the Federal Reserve's (Fed) policy response.

The Fed enacted its initial rate hikes during the quarter and indicated more would follow, acknowledging the challenge of reducing inflation without triggering a recession.

While the US economy showed signs of strength, there were indications of a slowdown. The 'flash' US composite purchasing managers' index (PMI) eased from 53.6 to 51.2 in June. The services component declined from 53.4 to 51.6, and manufacturing output dropped from 55.2 to a two-year low of 49.6. The PCE inflation, the Fed's preferred price gauge, remained unchanged at 6.3% year-on-year in May.

All sectors saw declines, though consumer staples and utilities were comparatively resilient. Dramatic declines were notable in the media & entertainment and auto sectors.

Eurozone

Eurozone shares experienced steep declines in Q2 amid the ongoing war in Ukraine, concerns about potential gas shortages, and rising inflation, which dented consumer confidence. The European Central Bank (ECB) is poised to raise interest rates in July.

Top-performing sectors included energy and communication services, while information technology and real estate faced sharp declines.

Continued disruption to gas supplies due to the war in Ukraine led Germany to move to phase two of its emergency energy plan. Inflation rose to 8.6% in June from 8.1% in May, with energy being the biggest contributor.

The ECB is set to raise interest rates at its July meeting, with another increase likely in September. Concerns about higher living costs and a potential recession saw consumer confidence fall to -23.6 in June, the lowest level since April 2020.

UK

UK equities fell in Q2. Economically sensitive areas of the market performed poorly towards the end of the period amid rising recessionary risks. Large-cap companies held up relatively well, with traditionally defensive sectors like telecoms, healthcare, and consumer staples outperforming.

In contrast, UK small and mid-cap companies (SMIDs) suffered due to their higher exposure to UK consumer-focused companies. Fears around high inflation and the cost-of-living crisis weighed heavily on stock valuations in these sectors.

Consumer discretionary sectors, such as retailers and housebuilders, performed poorly, mirroring trends seen across other developed markets grappling with high consumer price inflation (CPI). Many UK SMIDs saw severe valuation declines, consistent with the broader trend for growth companies amid rising interest rates.

UK Chancellor Rishi Sunak unveiled measures to help households facing higher energy bills, expected to offset some of the impact of higher prices later in the year.

The Bank of England increased its official rate by a combined 50 basis points (bps) with two consecutive 25 bps hikes, bringing the Bank Rate to 1.25%. The Bank continued to warn of higher inflation, raising its peak CPI estimate from 10% to 11% for October.

Japan

The Japanese stock market ended Q2 lower. The yen weakened sharply against the US dollar, breaching the 130 level for the first time in 20 years.

Japan's equity market was driven by news on monetary policy and currency markets, along with concerns over a potential US recession. The Fed's interest rate increase in April widened the interest rate differential with Japan earlier than expected. The Bank of Japan (BoJ) confirmed no change in policy at its April meeting.

The yen's weakness coincided with the reversal of several factors, including mobile telecom charges, contributing to a jump in core CPI (excluding only fresh food) to 2.1% in May.

Corporate results announcements began in late April for the fiscal year ended in March, with most companies reporting in May. Despite the challenging macroeconomic backdrop, the overall results and guidance were slightly better than expected.

Asia (ex Japan)

Asia ex Japan equities posted a negative return in Q2 as investor sentiment soured over rising global inflation and ongoing supply chain issues, exacerbated by the war in Ukraine.

South Korea was the worst-performing market in the MSCI Asia ex Japan index, with financials, technology, and energy stocks hit hard by global recession fears.

Stocks in Taiwan also declined due to concerns over inflation and supply chain issues. Indian stocks fell as global volatility, rising inflation, and soaring energy prices dampened investor sentiment.

The Philippines, Singapore, and Malaysia recorded sharp declines, mirroring global market trends, while declines in Indonesia and Thailand were less severe.

China was the only index market to end the quarter positively as Covid-19 lockdown measures were relaxed. Investor sentiment improved with government data showing growth in factory activity in June.

Emerging Markets

Emerging market equities fell in Q2, with US dollar strength being a key headwind, though they outperformed developed market peers.

Latin American markets like Colombia, Peru, and Brazil were among the weakest due to concerns over a global recession, domestic policy uncertainty, and weaker industrial metals prices later in the quarter.

Emerging European markets, including Poland and Hungary, underperformed due to geopolitical risks from Russia's invasion of Ukraine. Central banks in both countries increased policy tightening, and Hungary announced windfall taxes on banks and large companies.

South Korea and Taiwan lagged as the outlook for global trade deteriorated. Conversely, China generated a positive return as lockdown measures eased and additional economic support measures were announced.

Global Bonds

Bonds sold off sharply in Q2, with yields rising amid persistent inflation, hawkish central banks, and rising interest rates. Bonds rallied towards the quarter's end due to rising growth concerns, slightly curtailing negative returns.

Inflation rates in major economies continued to run at multi-decade highs, prompting various central banks to raise interest rates or signal intentions to do so.

Growth concerns mounted, with economic indicators reflecting moderating or slowing activity towards the period's end.

The US consumer price index increased by 8.6% year-on-year in May, accelerating unexpectedly. The Fed raised the policy rate by 75 bps in June, its first increase of this magnitude since 1994, and cut 2022 growth forecasts. The US 10-year bond yield rose from 2.35% to 2.97%, and the two-year yield from 2.33% to 2.93%.

European yields were volatile as the ECB indicated it would end asset purchases early in Q3 and raise rates soon after, leading to a sell-off in Italian yields. The ECB held an extraordinary meeting to discuss an “anti-fragmentation” program to support heavily indebted nations.

The German 10-year yield increased from 0.55% to 1.37%, while Italy's yield rose from 2.04% to 3.39%, peaking at 4.27% in June.

In the UK, the BoE implemented further rate hikes, bringing the total to five in the current cycle, and raised its inflation forecast to 11%. The UK 10-year yield increased from 1.61% to 2.24%, and the two-year yield from 1.36% to 1.88%.

Corporate bonds underperformed government bonds amid the broad sell-off, with high yield credit particularly hard hit due to economic concerns. Emerging market (EM) bonds also suffered significant declines as EM currencies weakened and the US dollar performed well.

The Refinitiv Global Focus convertible bond index shed -12.2% in US dollar terms, though convertible bonds protected investors from some equity market losses. New issuance of convertible bonds remained lackluster, with only $5 billion in new convertibles in Q2.

Commodities

The S&P GSCI Index achieved a positive return in Q2, with higher energy prices offsetting sharp declines in other components. Energy was the best-performing component due to rising demand and supply constraints from the ongoing conflict in Ukraine.

Industrial metals were the worst-performing component, with sharp falls in the prices of aluminum, nickel, and zinc. Copper and lead prices also declined significantly. In agriculture, wheat, corn, and cotton prices fell. In precious metals, silver saw significant declines, while the drop in gold prices was less pronounced.