Stock and bond markets have witnessed a surge of volatility since the start of the year. This has been a difficult year to be an investor, and many are nervous about the future of markets and the economy. We are writing this analysis to try and help make sense of what is happening in markets.
It is challenging to reconcile the strength of the economy with the performance of markets year-to-date. Growth in corporate earnings, rising wages, high levels of consumer saving and spending, and low unemployment rates are all indicators of a strong economy and would typically provide support for continued market growth. But this market environment is anything but typical, and a strong underlying economy has not been enough to prevent significant declines in both the equity and fixed income markets.
Inflation, the drivers behind it, and the actions to curb it are at the core of the re-pricing we are witnessing this year. The pandemic threw a one-two punch at the supply-demand equation for goods. Massive stimulus by governments around the world put cash in the pockets of consumers and businesses and slashed interest rates to spur the economy. At the same time, factories closed, and supply chains crumbled. As consumers and businesses went on shopping sprees, factories and suppliers were hobbled. The Federal Reserve, cautious about disrupting the recovery and believing inflation would be transitory, failed to act in 2021. Meanwhile, markets roared back after the initial pandemic drops and continued to rise at a rapid pace until the end of 2021.
Entering 2022, the economy was running too hot, inflation was proving persistent, and the Federal Reserve realized that it had failed to act for too long and was going to need to be aggressive to compensate for its complacency. With stubborn inflation, the Federal Reserve has been increasingly raising expectations for how quickly and aggressively it will tighten policy to dampen demand within the economy. We have witnessed a cycle of inflation staying persistently high, the Federal Reserve reacting by becoming more aggressive, and the market reacting to those new expectations.
Meanwhile, geopolitical and other events have exacerbated existing problems. China went into lockdowns, slowing the untangling supply chains. The war in Ukraine has significantly disrupted energy, food, and fertilizer supply, adding to upward pricing pressure.
While it may be difficult to see through the market turmoil and find a silver lining, we encourage investors to keep the markets in perspective of the broader economy. The Federal Reserve needs to tighten to slow the economy down because the economy is and has been running hot. A strong economy is a good thing. Corporate earnings continue to grow, and revenues of the S&P 500 companies are expected to grow near 10% over the previous year in the second quarter. While consumers are starting to spend down some of the savings built up during the pandemic, savings levels are still high in the U.S. Unemployment is near record lows, and anyone who wants a job right now should be able to find one. Backlogs of cargo ships waiting to unload at ports are falling, and exports out of China surged in May. Many corporations took advantage of low rates over the past few years and locked in low-cost, long-term debt, which will defend them against rising rates in the near term. Regarding inflation, it is proving persistent and will likely do so for some time, but we are starting to see some cracks. Applications for mortgages to purchase a home fell by over 20% from the previous year last week, and rising inventories of some goods are a sign of slowing demand. This is an environment where even good news can be bad for the market. Indicators that the economy is strong also imply that demand is still robust, which means the Federal Reserve may need to tighten more. Normally, indicators of a strong economy are just good news, not also bad news.
This is a very challenging investing environment, and we encourage our clients to take a long-term perspective and a steady hand during these difficult times. Here at Condor, we are continuously monitoring markets and positioning our portfolios for tomorrow while maintaining diversification. Last year, we increased our exposure to value segments, which have categorically been weathering this storm better. We have maintained an underweight position on international markets as we continue to believe in the strength and resiliency of the U.S. economy. Domestic equities have continued to outperform international equities. In our Strategic Growth strategy, we have avoided companies with low or no current profits and high valuations. We have also introduced some more value-oriented names. Our disciplined focus on profitable companies that provide investors both value today and the opportunity for future growth has kept this strategy oriented towards the middle part of the value-growth spectrum. In our fixed income portfolios, we have limited our exposure to longer-duration bonds that are more sensitive to rising rates. Additionally, we are taking advantage of this market correction to reduce client tax bills in 2022 by actively tax-loss harvesting. We will continue to look for and execute on opportunities to realize losses now and going forward.
At Condor, we place our clients first and value and respect the trust clients have in us. We will continue to monitor this rapidly changing economic environment and strive to be a reliable and steady partner as our clients work towards their long-term financial goals.
