Q2 - Market volatility and uncertainty continued, but is the worst behind us?
Higher inflation, a hawkish pivot by central banks and increasing fears of a recession weighed on both equities and fixed income during the second quarter. Unfortunately, there was no reprieve from the volatility of the first quarter.
The S&P 500 Index fell into bear market territory with a drop of 20.9% year to date, while the S&P/TSX Composite Index suffered a correction, falling by as much as 15.2% from its March 29 high.
Commodity prices contributed to the downside volatility. While oil prices remained at elevated levels, finishing modestly higher on a quarter-over-quarter basis at US$105/bbl, the broader commodity complex fell. Lumber, natural gas and copper were each down from their respective highs. Copper prices in particular have fallen by more than 25% from their high in March, along with other industrial metals, suggesting a softening of demand and perhaps a global economic slowdown.
Overall, it was a quarter of continued uncertainty, from the ongoing war in Ukraine, inflation, the path of interest rates and the global economy.
The S&P/TSX Composite Index fell from its March 29 all-time high, with a drop of 14.1% during the quarter putting the market into correction territory. The energy sector remains positive year-to-date on higher oil prices but was unable to avoid the volatility in Q2. The S&P/TSX Composite Index is trading at attractive valuation levels near the lows of the last 10 years.
The S&P 500 Index fell for the second consecutive quarter on inflation and recessionary fears. Every sector was down, with the weakest being the technology, communications and consumer discretionary. The S&P 500 Index has completed the first half of 2022 with the third weakest return since 1932. Only in 1962 and 1970 did the S&P 500 Index fall further in the first half of the year, but in each of these cases the second half was much stronger, with returns of 15.3% and 26.7% respectively.
China’s zero-COVID policy weighed on growth in Asia while Europe continued to struggle with the economic effects of the war in Ukraine. Emerging markets have modestly outperformed the S&P 500 Index (in Canadian dollars) year-to-date, likely because EM equities were further along in the bear market, having peaked in 2021. European equities performed modestly better than the U.S., as better valuation found in Europe may be providing some support.
Canadian and global fixed income benchmarks including corporate bonds were down sharply as yields rose. The benchmark 10-Year U.S. Treasury yield rose from 2.34% to 3.01% by quarter-end. Central banks have indicated their willingness to risk economic weakness to tame inflation. The Bank of Canada raised its benchmark overnight rate twice during the quarter to its current rate of 1.5%, with expectations that policy rates may hit 3% by December.
The outlook for the remainder of 2022 has moderated since last quarter. Central banks in North America have committed themselves to taming inflation with rapid interest rate increases. The current market belief is that central bankers will push the U.S. and Canadian economies (potentially among others) into a recession. It remains to be seen whether central bank policy and the slower economic growth will translate into a recessionary environment in the United States or Canada.
However, recent market activity and investor sentiment might suggest that the worst is behind us.