HIGHLIGHTS
- After enduring the worst six-month start to a year since 1970, the S&P 500 bounced back with strong gains in July – its strongest month since 2020. Furthermore, bonds also enjoyed solid results as yields continued to fall from their mid-June peak.
- The 10-year U.S. Treasury yield ended June at 2.98% following a multi-year closing high of 3.49% on June 14th. Rates continued to drop in July, ending the month at 2.67%. This sharp decline in rates helped bonds advance in July.
- For the second straight month, the Fed made a bold move by raising the Fed Funds Target Rate by another 0.75%. The Fed has raised rates by 225 basis points since March. Strong market gains leading up to and following the FOMC meeting seemed to reflect that this hike was largely priced into the market.
- U.S. economic growth has moderated in light of tighter financial conditions. Inflation readings remained high and manufacturing slowed, but the job market continued to make solid advances. The housing market is starting to feel the impact of higher mortgage rates as home market activity has slowed as well.
- We believe the economy is going through a growth scare, but we still expect positive economic growth for all of 2022. Corporate earnings will be important to monitor as earnings estimates have come down only modestly so far this year and more reductions might be necessary as the economy slows.
EQUITY MARKETS
Stocks behaved much better in July with gains across the board. As stocks advanced, volatility dropped to its lowest level since April. While this reprieve in the stock market was welcomed, the broad equity indices are still well below levels from the beginning of the year. We had expected a more volatile and challenging first part of 2022 and a more constructive market in the latter part of the year. One month does not make a trend, but the second half of 2022 has clearly started on much stronger footing than the first half of the year. Concerns still exist about this Fed rate hike cycle and how much that might slow economic growth, even to the point of a potential recession. Inflation also remains elevated and midterm elections loom. However, much of that seems to have already been discounted in stock prices, and as investors look beyond these near-term challenges, opportunities exist. Style and size were consequential in July with growth and small/mid-caps rebounding the strongest compared to large-cap value. Gains were enjoyed across the board, but those areas that had been under the most pressure so far this year enjoyed the best results in July. With very little fanfare, the S&P 500 closed the month +12.6% from its closing low on June 16th.
We still believe that the value/growth disparity that reached a peak in 2020 will likely continue to shift as we move through 2022 with value improving on a relative basis. That has clearly been the case so far this year, but July saw a shift to this trend. However, we believe value will still likely outperform growth on a relative basis over the near future. This better relative performance of value stocks so far this year has coincided with a rise in interest rates, which can put pressure on growth stocks. Likewise, as rates have dropped from their mid-June highs, growth stocks have rebounded. We continue to use our disciplined approach of seeking out what we believe to be high-quality companies with improving business conditions at what we believe are good prices, which those companies can be found in both the value and growth universe.
The numbers for July were as follows: The S&P 500 gained 9.22%, the Dow Jones Industrial Average advanced 6.82%, the Russell 3000 rose by 9.38%, the NASDAQ Composite rallied 12.39%, and the Russell 2000 Index, a measure of small-cap stocks, jumped 10.44%. For the first seven months of 2022, the returns in the same order were as follows: -12.58%, -8.60%, -13.70%, -20.47%, and -15.43%.
Looking closer at the impact of style and the clear relative outperformance of growth in July, the headline Russell 1000 Index advanced 9.31% in July while the Russell 1000 Growth Index rallied 12.00% and the Russell 1000 Value Index gained 6.63%. For the first seven months of the year, those two indices were down -19.44% and -7.08%, respectively. Growth outperformed value in July, but value has shown better relative results for the majority of the year. Small caps had a better overall July than large caps, with the bias favoring growth in this space as well. The Russell 2000 Value Index advanced 9.68% in July, while the Russell 2000 Growth Index rallied 11.20%. Year to date, those indices are still down -9.30% and -21.55%, respectively.
International stocks were mixed in July and clearly lagged U.S. markets. The MSCI ACWI ex USA Index, a broad measure of international equities, rose 3.42% for the month, and was off -15.63% year to date. The MSCI Emerging Markets Index actually slid modestly lower in July, down -0.25% and was off by -17.83% year to date. As would be expected with the Russian invasion of Ukraine, emerging Eastern European stocks have been the worst regional area this year.
FIXED INCOME
The yield on the 10-year U.S. Treasury continued to move lower in July after hitting a multi-year closing high of 3.49% on June 14th. The market focus seems to be shifting toward recession fears compared to inflation worries. As a result, bond yields further out on the yield curve have declined, but short-term rates, due to the ongoing Fed tightening cycle, have moved higher. The yield curve has been flattening over the last several weeks, a more typical outcome one would expect during a Fed tightening cycle. Overall, the 10-year U.S. Treasury ended June at 2.98% and dropped to 2.67% by the close of July. It is worth remembering that the 10-year yield ended 2021 at 1.52%, so this year has seen rates move significantly higher. Although bonds have been under pressure so far this year, the last several weeks have been better for bond results as rates have turned lower.
Fixed income returns were as follows for July: the Bloomberg U.S. Aggregate Bond Index gained 2.44%, the Bloomberg U.S. Credit Index rose by 3.04%, the Bloomberg U.S. Corporate High Yield Index rallied 5.90% and the Bloomberg Municipal Index gained 2.64%. The 30-year U.S. Treasury Index gained as yields fell and advanced 2.70% for the month, while the general U.S. Treasury Index gained 1.59%. For the first seven months of 2022, the returns for these indices in the same order were as follows: -8.16%, -11.19%, -9.12%, -6.58%, -21.51%, and -7.69%.
Clearly, bonds have struggled this year as there has been a repricing of interest rates across the yield curve and most bond sectors. Recall that in 2021, the Bloomberg U.S. Aggregate Bond Index recorded only its fourth annual decline since its inception in 1976 – and the worst year on record for the Agg was 1994 when it declined -2.92%. As it turns out, the year 1994 was another period when the Fed was in a rate hike cycle. We maintain our long-standing position favoring credit versus pure rate exposure in this interest rate environment. We also believe that the role bonds play in a portfolio, to provide stable cash flows and to help offset the volatility of stocks in the long run, has not changed.
Source: Clark Capital Benchmark Review, August 2022
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