The specter of long-term inflation loomed over the markets during the 2nd Quarter of 2022. As the 12-month Consumer Price Index (CPI) hit a 40-year during the quarter, people wondered exactly what the Fed meant by saying inflation was transitory. It sure didn’t seem like it.
As a result, investors felt they had two dreadful choices: 1) inflation would eventually drown out economic growth, or; 2) the Federal Reserve would kill economic growth by killing inflation with higher interest rates. In this sort of a gloomy scenario, investor psyche plummeted, and nothing seemed to work.
Stocks, as defined by the S&P 500, had their worst quarter in roughly 50 years. If you think that is bad, by some measures, the bond market has had its worst start to a calendar year since before the Civil War. Finally, while cash hasn’t fallen like stocks and bonds, inflation has taken a big bite out of the US consumer’s purchasing power.
In a lot of ways, every way actually, it was great to see the 2nd Quarter’s taillights.
Interestingly, the economic data hasn’t been as bad as the markets would suggest. To be sure, growth has been less than in was in 2021. However, outside of an explosion in our trade deficit, domestic output has been okay. Not great, but still not the worst case scenario so many had thought it was.
This takes us to the 3rd Quarter of 2022. The labor market remains tight. Banks are still flushed with liquidity. If you liked stocks at the start of the year, you should love the valuations now. Longer-term inflation expectations are moderating, so bonds likely won’t fall apart like they have thus far this year. This means stock prices should rebound from the 2nd Quarter’s red ink.
It hasn’t been fun, but it appears as though there is some light at the end of the tunnel. Let’s keep our fingers crossed the market funk is truly, to use the Fed’s word, transitory.
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