Market Commentary & Forecast

As we close out the third quarter, we find markets still struggling to digest the economic and financial cross-currents triggered by global inflation and the efforts of central banks to combat it. Growth continues to trend downward almost everywhere, prompting European equities to soften and China-dominated emerging markets indexes to decline more steeply. In the U.S., too, stocks gave back some of the year’s gains as the Federal Reserve’s record-setting rate-hike campaign helped to cut both inflation and growth roughly in half. Yet U.S. markets are faring better than most others on a year-to-date basis, supported by remarkable resilience in consumption and employment. In cap-weighted indexes, a handful of high-fliers have even kept returns solidly positive—the S&P 500 remains up 13.3% so far this year—despite more modest gains in average earnings.

As we approach the heart of summer, economic and geopolitical waves seem to be breaking almost nonstop, creating confusing crosscurrents for investors struggling to get their bearings on inflation, growth and market prospects. For its part, the U.S. Federal Reserve last week decided—reasonably enough—to take stock, holding the fed funds rate at 5.25% after hiking from near zero in a record- breaking 15 months. Yet the churn of news continues. In the U.S., economic tea leaves are scrutinized in an effort to reconcile resilient stock and labor markets, disparate pricing data for various goods and services, and the future path of monetary policy. Across the pond, the Eurozone appears to have entered at least a mild recession amid stubborn inflation and wobbly business confidence, all complicated by the protracted war in Ukraine. Further east, Beijing has finally restarted China’s economic engine after sunsetting the world’s most restrictive Covid policy, yet both domestic and export-related data suggest the recovery there remains underwhelming at best.

Just three months ago, the Clear Harbor team was preparing investment strategies in anticipation of a year of declining profit margins, ebbing inflationary pressures, and a monetary pause or even pivot. While much of this is indeed evolving as expected, it is once again an “unknown unknown” that has emerged as the primary story shaking up investor perceptions and driving market performance: the collapse of Silicon Valley Bank (SVB) in California and Signature Bank in New York. These failures have put hundreds of other independent and regional banks under pressure from depositors and investors, while leaving regulators and lawmakers scrambling to understand the causes and forestall a crisis. Before I delve into that subject and its implications for the markets, let me state as clearly as I can: Clear Harbor’s commitment to safeguard client assets is expressed at many levels, from our own internal controls to our custodial banking relationships with financially stable market leaders such as Pershing and Schwab. Likewise, our collective experience during the 2008-2009 financial crisis keeps the entire team mindful at all times of the structure and safety of deposits and short-term cash, money market funds, and fixed income securities (chiefly Treasury bills).

2022 provided ample reminders that markets are driven by human forces, and can be just as mercurial. Indeed, those concerned with prospects for major asset classes in the new year must continue to scrutinize the ever-evolving steps in the monetary and economic dance as central bankers, corporate leaders and ordinary consumers—humans, all—strive to find their footing amidst various uncertainties. Still, certain trends came into clearer focus over the course of the year. The pandemic and the war in Ukraine have created, highlighted or greatly accelerated changes that are structural in nature. In some cases, such as Europe’s renewed urgency on clean energy or America’s re-shoring of certain supply chains, they may prove nothing short of tectonic. With the cost of capital no longer virtually zero, such considerations carry great weight with us as we consider how consumers, businesses, and investors will behave not just in the next four quarters, but in the years that will follow.

Shifts in the economic, geopolitical and societal landscape have proved dizzying of late. The quarter about to end has seen a dramatic counteroffensive by Ukrainians against their Russian adversaries, “Zero Covid” policy thwarting growth in China, the passing of Queen Elizabeth II and a new sovereign and Prime Minster in the UK, and persistent inflation and climate-related dislocations around the world. Many questions at the intersection of business and politics remain. Will China’s coziness to Russia and other foes of democracy prod corporations to adjust supply chains and relocate production facilities to freer lands? If so, how will it impact profits and margins—the most significant long-term drivers of equity values? How much will the war in Ukraine exacerbate European energy shortages, fostering dangerous inflation and increasing recessionary pain on the Continent? On a global basis, will similar pressures usher in ever-more populist, and perhaps even undemocratic, political movements? Mark Twain is believed to have remarked: “History never repeats, but it often does rhyme.” While some of today’s economic and political trends may echo what has come before, the confluence of considerations are unique. On a number of fronts, consensus thinking may well be in the midst of significant change, as one regime—whether literal, monetary or otherwise—ends and another begins.

Both for the quarter and year-to-date, volatility was up and prices were down across major asset classes, particularly in equities and fixed income. On the equity front, the MSCI All World Index has declined 13.1% for Q2 and 17.6% YTD; the S&P 500 is off 13.6% and 17.6% respectively for the same periods. After a weak 2021 relative to developed-market indexes, Emerging Markets have fared a bit better so far this year, with the MSCI Emerging Markets Index off a slightly gentler 9.2% in Q2 and 15.5% YTD. On the bond front, the broad U.S. fixed income benchmark, the Bloomberg Aggregate Bond Index, has fallen 5.7% in the quarter and 11.2% YTD. Gold, that traditional shock absorber against market bumps, is unchanged for the year to date, but has given up 5.9% in the quarter as the dollar surged to historically high levels. We view gold as an alternative currency, and therefore believe that its recent ebb is somewhat rational in response to dollar strength. However, as U.S. and global growth slow, I believe that gold is reasonably well positioned to outperform a broad mix of global fiat currencies. Energy is of course up dramatically, with WTI crude oil rising 9.2% in Q2 and 45.7% YTD; natural gas prices in North America have gained 15.2% during the quarter and 74.2% YTD. With that said, domestic prices have trended lower over the last few weeks: the back half of June has seen oil correct by 11.0% from its recent peak, with U.S. natural gas retreating an eye-catching 33.1%. Prices in Europe do remain quite elevated, clearly in response to sharp supply constraints from the war in Ukraine and Russia’s decision to withhold flow.