The Independent Market Observer

Looking Back at the Markets in Q2 and Ahead to Q3 2022

Posted by Brad McMillan, CFA®, CFP®

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This entry was posted on Jul 7, 2022 2:10:13 PM

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Looking Back and AheadJune was a terrible month for the markets, capping off a disappointing second quarter. The S&P 500 lost 8.25 percent during the month and 16.1 percent for the quarter; the Dow Jones Industrial Average lost 6.56 percent during the month and ended the quarter down 10.78 percent; and the Nasdaq Composite lost 8.65 percent in June and 22.28 percent for the quarter. The Nasdaq Composite also saw the largest monthly and quarterly declines due to its heavier weighting on beaten-down technology stocks.

Looking Back

Interest rates. For most of the quarter, interest rates drove the markets, taking valuations down. But by June, valuations were back to pre-pandemic levels. As rates started to pull back a bit, markets started to worry about a recession and its effect on corporate profits. It was a different worry but had the same result, as markets tanked on earnings fears in June rather than on rate fears.

Inflation. The Fed is now publicly committed to keeping rates rising until inflation is under control. But there are signs that inflation is moderating, and markets now expect the Fed to start cutting rates sometime next year. On the inflation front, commodity prices have pulled back substantially, including oil, which will help moderate inflation. In other words, June may have seen peak fear, and the third quarter could benefit as some worries recede.

The economy. Despite the worries and market pullbacks, most of the economy continued to grow in the second quarter. Hiring, in particular, remained strong. And while consumer confidence dropped, it remained at growth levels, supporting spending and economic growth. Consumer confidence was hit hard by higher gas prices, but as oil prices have pulled back, confidence should rebound as well. Business confidence and investment were also strong for the quarter. So, while there were some signs of slowing, overall growth continued.

Looking Ahead

The Ukraine war. Besides inflation and interest rates, the second quarter was dominated by news from the Ukraine war and the Chinese Covid-19 shutdowns, which threatened to disrupt supply chains once again. Looking forward to the third quarter, both of those risks have stabilized. China’s economy is largely open again, and the Ukraine war is settling into a stalemate. For the moment, the damage has paused and may continue to subside; this is also part of the reason why oil and wheat prices have started to pull back. That said, the third quarter looks like it will be more stable than the second.

Potential for turbulence. That’s not to say we will not see more turbulence this month—inflation and interest rates could rise further, Covid-19 could surge again, and the Ukraine war could expand. And when and if those bad things happen, we will see more market volatility. So, as always, the headlines will drive short-term market performance.

Valuations and earnings. Valuations are now back to typical levels, and earnings should continue to do better than expected, as they did in the second quarter. Much of the bad news now looks to be priced into markets. With the economy solid and worries starting to moderate, we should see valuations remain stable and possibly improve. We may even see some appreciation as fears about earnings growth moderate.

Fundamentals. Despite the headlines, fundamentals are what drive both the economy and the markets. The second quarter saw the markets drop around both the adjustment in rates and the fears of what might happen. The third quarter should see markets start to stabilize around the current rates, where expected increases are already priced in with a more realistic set of expectations. So, while there may be more volatility, we are moving in the right direction, and the fundamentals remain sound.

A Potential Path to Growth

We started the second quarter with the fear that bad things could happen—but we saw that these things were not as bad as initially feared. As we move into the second half of the year, many of those worries have already been priced in, while others do not look nearly as bad as they did a couple of months ago. This is real progress.

The second quarter was when markets also digested the idea of higher rates and slower growth. The third quarter will be when we move on with a better appreciation of what that actually means. As such, we should see more stability—and even the potential for growth. So, while we’ve seen substantial volatility, and may see more, this provides a good foundation going forward.

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