June Weakness Leads to Worst First Half in Decades
HIGHLIGHTS:
- Stocks and bonds took another step lower in June. The S&P 500 Index recorded its largest quarterly drop since the second quarter of 2020, and the first half of 2022 was the worst for this index since 1970.
- The Fed flexed its muscle once again in June raising the Fed Funds Target Rate by 0.75%, its largest single increase since 1994. This increase in rates pressured both stocks and bonds lower during June.
- The 10-year U.S. Treasury yield ended June at 2.98%, well above the 2.32% level from the end of the first quarter and 2.85% at the end of May. However, rates dropped sharply over the last two weeks of June after hitting a multi-year high of 3.49% on June 14.
- U.S. economic growth has slowed in light of tighter financial conditions. However, the job market continues to reflect strength as the unemployment rate was only 3.6% in May. The torrid housing market is starting to feel the impact of higher mortgage rates, which have more or less doubled in 2022.
- We believe the economy is going through a growth scare, but we still expect positive economic growth in the second quarter and for 2022. Corporate earnings will be important to monitor as earnings estimates have only come down modestly so far this year, and more reductions might be necessary.
EQUITY MARKETS
Volatility remained elevated for much of June as stocks declined further. Equity market weakness in June pushed many major equity indices into negative double-digit territory for the quarter. This decline was on the heels of negative first quarter results, which made the first half of 2022 the worst six-month start to a year since 1970. Our expectation of more volatility in 2022 and a stock market correction in the first half of the year has occurred. Furthermore, fears continue to mount regarding an economic slowdown as the Fed aggressively raises rates. With the Fed tightening, high inflation levels, and mid-term elections still looming, volatility will likely continue in the third quarter. Style and size were of little consequence in June, but for the quarter and year-to-date, value clearly outperformed growth and large-caps did better than small-caps on a relative basis.
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 been the case so far this year. This does not preclude growth stocks from improving and having periods of outperformance as well, but we believe value will still likely outperform growth on a relative basis over the near future. The relative outperformance of value stocks has coincided with a rise in interest rates, which can put pressure on growth stocks. We at Clark Capital 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.
The numbers for June were as follows: The S&P 500 fell -8.25%, the Dow Jones Industrial Average dropped -6.56%, the Russell 3000 declined by -8.37%, the NASDAQ Composite fell -8.65%, and the Russell 2000 Index, a measure of small-cap stocks, slid -8.22%. For the second quarter, the returns in the same order were as follows: -16.10%, -10.78%, -16.70%, -22.28%, and -17.20%. For the first six months of 2022, the returns in the same order were as follows: -19.96%, -14.44%, -21.10%, -29.23%, and -23.43%.
Looking closer at the impact of style and the relative outperformance of value so far this year, the headline Russell 1000 Index fell by -8.38% in June. The Russell 1000 Growth Index declined -7.92%, while the Russell 1000 Value Index dropped -8.74%. For the second quarter, the Russell 1000 Growth Index was down -20.92%, while the Russell 1000 Value Index was off -12.21%. For the first six months of the year, those two indices were down -28.07% and -12.86%, respectively. Growth outperformed value in June, but value has shown better relative results for most of the year. The same trend holds true for small-caps from a style perspective in June, as well as for the second quarter and year-to-date. The Russell 2000 Value Index dropped -9.88% in June, while the Russell 2000 Growth Index declined -6.19%. For the quarter, those two indices were lower by -15.28% and -19.25%, respectively. Year-to-date, they are down -17.31% and -29.45%, respectively.
International stocks struggled in June as well. The MSCI ACWI ex USA Index, a broad measure of international equities, declined -8.60% for the month, dropped -13.73% for the quarter and was off -18.42% so far this year. The MSCI Emerging Markets Index fell -6.65% for the month, was down -11.45% for the second quarter, and was off by -17.63% year-to-date. As would be expected with the Russian invasion of Ukraine, emerging Eastern European stocks have been the worst performers this year, down -10.2% in June, -23.67% last quarter, and -83.46% year to date.
Fixed Income
The yield on the 10-year U.S. Treasury moved higher throughout the first half of June, hitting a multi-year closing high of 3.49% on June 14. However, yields moved dramatically lower in the latter part of the month as recession concerns mounted, which resulted in the belief that the Fed rate hike cycle might end sooner and at a lower level than previously thought. As equities weakened in June, there was likely a flight to quality as well with yields at levels not seen in some time. Despite this late-month drop, yields moved higher overall in June, with the 10-year ending June at 2.98% compared to May’s close at 2.85%. Wrapping up the first half of 2022, it is worth remembering that the 10-year yield ended 2021 at 1.52%, so this year has seen rates move significantly higher. The bond market saw declines across the board in June, further exacerbating weakness in the second quarter and year-to-date.
Fixed income returns were as follows for June: the Bloomberg U.S. Aggregate Bond Index fell -1.57%, the Bloomberg U.S. Credit Index dropped -2.61%, the Bloomberg U.S. Corporate High Yield Index slumped -6.73%, and the Bloomberg Municipal Index declined -1.64%. The 30-year U.S. Treasury Index continued to be weak as it slid an additional -1.62%, while the general U.S. Treasury Index fell by -0.88%. For the second quarter, the returns for these indices in the same order were as follows: -4.69%, -6.90%, -9.83%, -2.94%, -13.73%, and -3.78%. For the first six months of 2022, the returns for these indices in the same order were as follows: -10.35%, -13.81%, -14.19%, -8.98%, -23.57%, and -9.14%.
Clearly, this has been an unprecedented start to the year for bonds. 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, 1994 was another period when the Fed was in a rate hike cycle. Last year was a challenging year for investment-grade bonds, particularly for U.S. Treasuries, as yields moved higher. Unfortunately, that trend has continued for most of 2022 and has broadened to other bond sectors as the market tries to gauge how aggressive the Fed will be in this rate-hike cycle, as well as the potential for a slowing economy. 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.
Economic Data and Outlook
The strength in job market data continued in May, but gains slowed from April. Non-farm payroll additions were 390,000, well ahead of expectations of 318,000. The unemployment rate remained at 3.6% in May when a drop to 3.5% was anticipated. The labor force participation rate came in as expected at 62.3%, a modest improvement from the disappointing 62.2% reading from the prior month. There were 11.4 million open jobs reported in April, which was ahead of estimates of 11.35 million, but lower than the prior month’s revised reading of over 11.8 million. There are still millions more jobs available than those searching for work, so this mismatch in the labor market continues. Job gains continue to be made following strong growth in the first quarter, but some moderation has occurred. Typically, one tends to see the unemployment rate start to rise heading into a recession, but at this point in the cycle, employers are still looking for workers to fill open roles. Ultimately, the job market is important to track with about 70% of U.S. economic activity driven by consumer spending.
The rise in mortgage rates seemed to take some of the steam out of the housing market once again in May. However, we are still in a position where strong demand and low inventories have resulted in home prices that continue to rise dramatically. Based on the year-over-year reading of the S&P CoreLogic CS 20-City Index, home prices surged higher by 21.23% in April, surpassing expectations. Building permits and housing starts were both well below estimates and lower than April’s levels. Existing home sales were just above expectations in May, but they too dropped from the prior month. New home sales recovered from a significant decline in April by comfortably surpassing expectations in May and improving from April’s mark. It seems unlikely that home prices can continue to surge higher as mortgage rates climb, but we have not seen any real slowing in pricing at this point. The housing market has been, and continues to be, a source of strength in the economy and has historically been a good leading indicator as well. However, the impact of higher mortgage rates will likely have a dampening effect on housing and ultimately slow the sharp rise in prices.
The ISM Manufacturing Index for May improved to 56.1, which was ahead of expectations of 54.5 and April’s reading of 55.4. However, the reading for June declined to 53.0 as the New Orders and Employment components recorded readings below 50 – the second month in a row for employment below the 50 level. The ISM Non-Manufacturing Index, which covers the much larger service industries in the U.S. economy, dropped to 55.9 in May – below estimates of 56.5 and the prior month mark of 57.1. Manufacturing and service industries are still showing growth, but following the recent trend, some moderation in the pace of growth has occurred. Recall that ISM readings above 50 indicate expansion and below 50 signal contraction, so these current headline readings remain in growth territory.
Retail sales (ex auto and gas) rose by 0.1% in May, below expectations of 0.4%. April’s reading was revised modestly lower to a 0.8% gain from the prior estimate of 1.0%. It is important to note that higher prices, meaning inflation, can be a significant factor for this reading as the retail sales data is not inflation adjusted. Consumer confidence, based on the preliminary University of Michigan Sentiment reading for June, dropped to 50.2. This was well below expectations of 58.1 and was the worst reading since the inception of this index. Ongoing concerns about inflation, worry about a recession, and continued weakness in the stock market clearly weighed on consumer sentiment. The final Michigan reading for June saw the index drop a bit further, but the good news was future inflation expectations dropped in that final reading as well.
The Conference Board’s Leading Index declined by -0.4% in May as expected. The final reading of Q1 2022 GDP showed a modestly deeper decline in activity to a -1.6% annualized rate from a previously reported -1.5% rate. The personal consumption component of GDP was revised lower to 1.8% annualized growth from 3.1%, reflecting less spending than previously estimated by households. We at Clark Capital understand that GDP growth will not be as strong in 2022 compared to 2021, but we are still anticipating positive growth in the second quarter and for 2022.
Inflation remains problematic for the Fed. With the Fed focused on containing inflation and inflation expectations, the Fed raised rates at the June FOMC meeting by 0.75% – the largest increase in rates since 1994. Inflation has surged to generational highs and the headline Consumer Price Index (CPI) rose more than expected in May (which was announced in June) by 8.6% on a year-over-year basis – the largest annual increase since the early 1980s. On a core basis, the 6.0% increase in May followed a higher reading of 6.2% in April. However, those two CPI readings for May were higher than expectations. The headline Producer Price Index (PPI) reflected another double-digit annual gain by rising 10.8% in May, a modest improvement from the 10.9% revised mark for April, and just ahead of expectations. Inflation will likely remain elevated throughout 2022, but we anticipate it will moderate as the year progresses. The Fed has signaled to the market that inflation is its focus, and it does not want higher inflation expectations to become rooted in our economy.
We remain resolute in our belief that the U.S. economy and corporate America will continue to recover as we progress beyond the pandemic. The shift in Fed policy from stimulative to more restrictive is having an impact on the economy. The Fed is focused on bringing inflation under control, but its primary tool in achieving that goal is raising interest rates, which is a headwind to economic activity. As we are transitioning away from the stimulus-fueled economy, more market volatility has been a result. Markets are resetting valuations based on higher interest rates and corporate earnings expectations. We believe economic fundamentals still look positive and we still expect the economy to grow this year. We understand that high single-digit earnings estimates will likely be adjusted lower, but corporations are still hiring new workers. We believe it is imperative for investors to stay focused on their long-term goals and not let short-term swings in the market derail them from their longer-term objectives.
Investment Implications
Clark Capital’s Top-Down, Quantitative Strategies
We believe the market is oversold due to very pessimistic investor sentiment. As such, we are closely watching for an intermediate-term rally attempt.
The Style Opportunity portfolio moved into a broad market ETF after we harvested losses from the S&P 500. The Fixed Income Total Return and Global Tactical strategies are positioned defensively, waiting for credit conditions to improve. Both strategies ended the month in cash equivalents and bought U.S. Treasuries on July 1st.
Clark Capital’s Bottom-Up, Fundamental Strategies
Across our equity portfolios, we focused on companies with strong cash flow and sustainable profitability. In fixed income, spreads widened consistently throughout the month as recession fears dominated the market.
Across the fixed income marketplace, outflows continued during June, which resulted in forced selling. Within Taxable Fixed Income, we continued to position the portfolio in shorter, higher-yielding bonds coupled with what we believe are high quality, longer bonds.
ECONOMIC DATA
| Event | Period | Estimate | Actual | Prior | Revised |
|---|---|---|---|---|---|
| ISM Manufacturing | May | 54.5 | 56.1 | 55.4 | — |
| ISM Services Index | May | 56.5 | 55.9 | 57.1 | — |
| Change in Nonfarm Payrolls | May | 318k | 390k | 428k | 436k |
| Unemployment Rate | May | 3.50% | 3.60% | 3.60% | — |
| Average Hourly Earnings YoY | May | 5.20% | 5.20% | 5.50% | — |
| JOLTS Job Openings | Apr | 11350k | 11400k | 11549k | 11855k |
| PPI Final Demand MoM | May | 0.80% | 0.80% | 0.50% | 0.40% |
| PPI Final Demand YoY | May | 10.90% | 10.80% | 11.00% | 10.90% |
| PPI Ex Food and Energy MoM | May | 0.60% | 0.50% | 0.40% | 0.20% |
| PPI Ex Food and Energy YoY | May | 8.60% | 8.30% | 8.80% | 8.60% |
| CPI MoM | May | 0.70% | 1.00% | 0.30% | — |
| CPI YoY | May | 8.30% | 8.60% | 8.30% | — |
| CPI Ex Food and Energy MoM | May | 0.50% | 0.60% | 0.60% | — |
| CPI Ex Food and Energy YoY | May | 5.90% | 6.00% | 6.20% | — |
| Retail Sales Ex Auto and Gas | May | 0.40% | 0.10% | 1.00% | 0.80% |
| Industrial Production MoM | May | 0.40% | 0.20% | 1.10% | 1.30% |
| Building Permits | May | 1778k | 1695k | 1819k | 1823k |
| Housing Starts | May | 1693k | 1549k | 1724k | 1810k |
| New Home Sales | May | 590k | 696k | 591k | 629k |
| Existing Home Sales | May | 5.40m | 5.41m | 5.61m | 5.60m |
| Leading Index | May | -0.40% | -0.40% | -0.30% | -0.40% |
| Durable Goods Orders | May P | 0.10% | 0.70% | 0.50% | 0.40% |
| GDP Annualized QoQ | 1Q T | -1.50% | -1.60% | -1.50% | — |
| U. of Mich. Sentiment | June P | 58.1 | 50.2 | 58.4 | — |
| Personal Income | May | 0.50% | 0.50% | 0.40% | 0.50% |
| Personal Spending | May | 0.40% | 0.20% | 0.90% | 0.60% |
| S&P CoreLogic CS 20-City YoY NSA | Apr | 21.05% | 21.23% | 21.17% | 21.15% |
Source: Bloomberg
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CCM-993
