Market review Q122

The first quarter was a turbulent one. Persistently high inflation prodded the Fed to get much more hawkish on monetary policy and the invasion of Ukraine by Russia threw commodities markets into turmoil.

It was also a punishing quarter for many investors. Stocks swooned and rebounded but still ended down for the quarter. Bonds were brutalized with one of the worst quarters ever. As such, it was also one of the few occasions for which balanced fund investors were not cushioned from the blows. The big question now is, was this just a blip or was it the beginning of a new and more hostile investment landscape?

Are we living in a dream world?

Despite all of the turmoil in the quarter, the S&P 500 finished down just 6% from its all-time high, though it had been almost 14% at one point. Such resilience in light of fairly substantial headwinds cast a surreal complexion over the landscape. Robert Armstrong captured the contradictions in the FT's "Unhedged" newsletter:

Inflation is scalding, and the Fed is vigilant. We are flirting with an inverted yield curve. And yet markets, judging by the Fed funds futures curve, stock prices, and other indicators, are saying we will glide through the next few years without the US central bank needing to raise rates to even 3 per cent, and without falling into recession.

He wonders, “Are we living in a dream world?” and then goes on to describe, “It is a weird form of cognitive dissonance: to talk as though you recognise the headwinds and not price them in. Hoping, perhaps, that they will not, after all, materialise.

A similar weird form of cognitive dissonance occurred last fall. With CPI prints coming in at high single digit levels and the Fed refusing to even tap on the monetary brakes, long-term interest rates nonetheless remained relatively insulated from such concerns, hovering around 1.5%. I addressed this issue in a market review in January. In hindsight, bond investors really were living in a dream world.

The weird form of cognitive dissonance also infected the geopolitical realm. Few people expected Putin to actually invade Ukraine, including many with business relations in Ukraine and Russia. With so many people so substantially failing to adequately account for identifiable risks, it begs the question, "Why?"