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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.

Russia's unprovoked attack on Ukraine has dealt a blow to economic expectations and the confidence of consumers and investors around the world. Year-to-date, global equity indices are off approximately 8%, while broad measures of fixed income have shed 5.5%. Meanwhile oil has surged more than 40%, gold is higher by more than 6%, and soft commodities and industrial metals are nearly all measurably higher as well. While we hope that Russia will halt their invasion and that the West can address the humanitarian crisis in Ukraine, our fear and base case is that this war will continue, leaving thousands more dead. It has already steamrolled key economic assumptions. When I peered into 2022 at the end of 2021, I forecasted higher market volatility in the face of rapidly waning fiscal stimulus and an incremental ebb from historically accommodative monetary policy in the U.S. However, I also believed that these shifts, coupled with a transition toward Covid as an endemic but more manageable public health concern, would allow inflationary pressures—albeit still historically elevated—to wane significantly in 2022.

Following a year in which Covid-19 steamrolled the economy and wrought havoc on lives around the world, 2021 brought a measure of long-awaited stabilization. Despite a still-rising death toll, new variants, and supply-chain problems pumping the brakes on the global reopening, the year is poised to end with significant economic momentum, backfilled in large part by record levels of debt-fueled fiscal stimulus. In the U.S., full-year GDP growth will likely register around 5.5% after contracting 3.5% in 2020. As we peer into 2022, we expect to see further normalization of the economic picture as supply-chain bottlenecks are improved, vaccination rates increase, and fiscal stimulus and key measures of inflation in the U.S. both decelerate. These trends should give the U.S. Federal Reserve latitude to begin unwinding their extraordinary asset purchases sparked by Covid, even as they continue to ponder the timing and degree of actual hikes in the Fed Funds Rate. Our view is that while the Fed would prefer to bring rates back toward a more traditional relationship with inflation, speed bumps in the economy as well as political pressures from massive debt could inspire a dovish posture for longer than many expect.