Q2 2022 Market Outlook

In March 2022, Good Life Advisors released a comprehensive market outlook for the upcoming quarter. Here is a summary of these findings.

Investors were treated to a rough start to 2022 as markets swooned, inflation ripped to 40-year highs, and the Federal Reserve began its march toward raising interest rates. In addition, disruptions happened in multiple arenas: stocks and bonds both fell, war broke out between Russia and Ukraine, and lockdowns in China due to COVID precautions hindered supply chains. Q2 will have a hard time topping the breakneck pace of news and unprecedented data, but there’s still plenty to be mindful of heading into the year’s midpoint.

Q1 Review

Q1 may have been many things, but boring certainly wasn’t one of them. Here’s a rundown of the major events in both financial markets and the geopolitical scene:

  • Russia’s invasion of Ukraine triggered shockwaves across the globe, and the consequences reached both Europe and North America. Gas prices jolted upward, and heavy sanctions were thrust upon Russia. As a result, the Russian economy contracted significantly as its markets crashed, the currency fell, and commodity prices soared. The ongoing war has had tremendous human costs and continues to strain commodity prices.
  • Despite its strict policies, China suffered a large COVID-19 outbreak, and the resulting lockdowns across Shanghai have thrown wrenches into many essential supply chains.
  • Inflation soared to levels not seen in more than 40-years, with the Consumer Price Index (CPI) ticking in just below 8% for the month of March.
  • Most major equity market indexes faced losses, especially high-growth stocks.
  • Bond markets also suffered significant declines.
  • Mortgage rates soared to multi-year highs.
  • The Federal Reserve signaled aggressive rate hikes throughout the remainder of the year.
  • The job market continued to be competitive, and unemployment fell to levels not seen since pre-pandemic times.

Equity Markets

Stocks ended the quarter down across the board, with the most pain coming in the NASDAQ. The tech-heavy index was down 8.9% overall in Q1, compared to declines of 4.1% in the Dow and 4.6% in the S&P 500. Growth stocks had a particularly bad time – the Russell 1000 Growth Index lost 9.5% compared to just a 1.6% decline in the Russell 1000 Value Index.

The shift from growth to value has been severe, but markets began trending away from growth toward the end of 2021. Many of the big winners during the height of the pandemic have been slashed by 60% or more. Investors eschewing growth for value is a trend we should expect to continue as interest rates rise and fundamentals take higher precedent over future expected growth rates. Volatility is likely to remain high as inflation, monetary policy, and geopolitical risks continue to apply pressure to stock prices, especially those companies without a history of profit or successful products.

Fixed Income Markets

Fixed income markets had an even tougher go than equity markets through the first quarter of 2022. Bonds faced their roughest quarter since 1980 with all areas of the market suffering declines except Treasury Inflation Protection Securities (TIPS). Barclay’s fixed income benchmarks in Q1 tell the tale:

  • US Aggegrate Bonds down 6.2%
  • US Corporate Bonds down 8.3%
  • US TIPS up 0.44%
  • US Mortgage-backed Securities down 5%
  • US Municipal Bonds down 6.2%

European fixed income markets haven’t been spared either as Emerging Market Bonds lost more than 10% and European bond markets in aggregate lost over 6%.

The dreaded yield curve inversion has arrived for US government bonds with the 2-year Treasury now yielding more than the 10-year Treasury. While an inverted yield curve is not an automatic recession signal, it does show that investors are beginning to get more concerned over a potential economic slowdown and Federal Reserve policy mistake. Yield curve inversions don’t always trigger recessions, but it usually happens within 18 months of the initial inversion.

Inflation Rate Increase and Tightened Monetary Policy

Inflation remains one of the biggest concerns amongst US consumers as the CPI continues to print at levels not seen since the 1970s. No matter which metric you look at, inflation has become a significant hindrance and the Federal Reserve is expected to be aggressive in hiking rates throughout the rest of the year.

CPI came in at 7.9% in February, followed by an 8.5% print in March. The Personal Consumption Expediture (PCE), the Federal Reserve’s preferred inflation measure, tallied 6.3% in March, the third straight month with a 6% year-over-year increase. Now facing the highest inflation in more than 40 years, the Federal Reserve hiked interest rates by 25 basis points in March.

On May 5, the Federal Reserve approved a half-percentage point interest rate increase in a response to high inflation. This is the most aggressive tightening of the U.S. monetary policy since 2000. This has left the market shaky as investors are assessing the implications of this decision. On Thursday, stocks opened lower, with technology stocks leading the way, and the S&P 500 dropped 1% in early trading. Tech-focused Nasdaq Composite Index lost 1.4% and the DOW edged down 0.9%. With 5 more meetings scheduled beyond May, the Fed is likely to be aggressive and hike rates by at least 25 basis points each time they convene.

By year end, the Federal funds rate is expected to be between 2.5% and 2.75%. A best case economic scenario would likely include CPI waning in response to these hikes, settling in at 3-4% between the next 1 to 2 years. But many things still remain beyond the Fed’s control, such as supply chain issues in China and the continuing war in Ukraine, and expectations of a recession continue to climb.

Labor Markets and Unemployment

One area of improvement has been the US labor market. March’s unemployment rate was 3.6%, which marked a complete recovery from pandemic-induced losses. Not only is unemployment low, but job openings and quits are near all-time highs, which signifies a tight labor market. Layoffs are also at historic lows and businesses are finding stiff competition for top-tier talent.

The tight job market has contributed to inflation as companies must enhance compensation to attract workers. Wage pressures could continue if equity markets suffer during a rising rate environment and high-paying jobs become more attractive to people outside the labor force. Many early retirees could return to work if their nest eggs take a hit during the aggressive rate hike cycle.

The Outlook for 2022

Pessimism reigns as Q2 gets underway with predictions of recession and economic decline dominating financial media. The 2-year and 10-year Treasury yields are inverted, an event that usually precedes a recession. Bond and equity markets have been rattled, while commodity prices continue to rise. Interest rates are going up and supply chain issues persist, but is the news all bad?

The outlook for 2022 is gloomy; however, interest rate hikes don’t always mean stock declines. Yield curve inversion may signal a recession on the horizon, but not imminently. In fact, stocks performed well for 6 to 22 months following the yield curve inversions in 1988, 1998, 2005, and 2019. The labor market has also been a positive, as the unemployment rate is back to pre-pandemic levels.

Uncertainty will be the theme of year as the country attempts to return to normal following a pandemic, war, and high inflation. Consumers might be pessimistic, but plenty of cash resides on the sidelines and personal balance sheets are stronger than previous periods of economic decline. Expect inflation to dominate headlines through the November midterms, but geopolitical tension and market volatility are likely here to stay for Q2.


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be investigated into directly.

Economic forecasts set forth may not develop as predicted and there can be no guarantee that strategies promoted will be successful.