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Quarterly Investment Commentary – July, 2022

Current Perspectives · July 27, 2022

The second quarter of 2022 was characterized by bad news and difficult economic
conditions. U.S. stocks entered bear market territory in the middle of the second quarter
and finished with the worst first six months’ return since 1970. Fixed income securities
did not provide much diversification benefit as interest rates rose.

Many factors drove economic uncertainty and a market sell-off. Inflation is at record
highs, Russia is threatening the global order, and Covid is not done with us yet (for
example, strict lockdowns in China continue to drive uncertainty in the supply-chain).

Economic reports are throwing mixed signals and there is not agreement among experts
regarding the direction of the economy. However, it is safe to say that the economy is
likely in or heading toward a recessionary period.

Most of us have, through life experience, learned that the economy and investment
markets are cyclical. The pathway to progress is not linear. Rather, both markets and
the economy expand and contract during different periods of history. Fortunately,
despite what they say on the evening news, things eventually go back to expansion
mode following contractions. Sometimes it happens quickly, and sometimes it takes
what seems like too long. But it does happen.

The financial planning process can help prepare in advance for the inevitable swings in
the market, and identify opportunities which may exist today brought about by bear
market conditions.

Today’s Economic Perspective

The U.S. Index of Economic Indicators fell again in May, fueled by tumbling stock prices,
a slowdown in housing construction, and gloomier consumer expectations. The leading
indicators suggest weaker economic activity is likely in the near term, and tighter
monetary policy is poised to dampen economic growth even further.

At the Federal Reserve, policy makers strive to strike a balance between keeping the
economy growing and controlling inflation. Currently the Fed is highly focused on curbing
inflation, which means we can expect higher interest rates. Chairman Powel has stated
that “restoring price stability is a nonnegotiable need. It is something we need to do . . .
there could be some pain involved.”

Two quarters of negative economic growth in a row are widely understood to constitute a
recession. There was economic contraction in Q1 2022, and the results are not yet in
for Q2. Forecasters are digesting mixed signals from economic data. For example,
those forecasting recession site record high inflation, Covid supply chain disruptions,
and Russia’s threat to the global order as headwinds to economic growth. Others with
more optimistic outlook site strong earnings estimates from corporations, strong
employment, and the recent decline in commodities pricing as signs of support for
continued growth.

Investment markets tend to be a forward-looking economic indicator, and markets are
clearly anticipating more difficult economic conditions. The good news is that markets
will likely move ahead well in advance of when we learn officially that the economy is
again on solid footing.

Today’s Market Perspective

The bad news in the investment markets continues. U.S. stocks entered true bear
market territory in the middle of the second quarter. Meanwhile, bond rates rose,
causing bond investors to suffer paper losses as well.

Losses were spread across the full investment spectrum. The Wilshire 5000 Total
Market Index—the broadest measure of U.S. stocks—lost 16.77% in the second quarter,
to slip into bear market territory at -20.89% for the last six months. The comparable
Russell 3000 index has lost 21.81% so far this year.

The most often-cited trigger for today’s falling stock prices is Fed policy. Fed Chair
Jerome Powell has publicly stated that his biggest concern is bringing down inflation,
and the Fed’s policy tool to accomplish that is the opposite of what would raise stock
prices: aggressively raising the Fed Funds Rate. A higher Fed Funds Rate drives up
short-term interest rates which, in turn, reduces liquidity in the economy, depressing
corporate investment and consumer borrowing. Directly related to consumer borrowing,
inflation is outpacing wage increases, making people feel less flush than they have felt in
the recent past, which is certain to depress consumer spending.

U.S. Corporations are certainly not worth 20% less today than they were six months ago.
In fact, 2022 profit expectations for the companies make up the S&P 500 have risen this
year. History would suggest that markets tend to overshoot both the upside and the
downside associated with the underlying conditions. Over the long run an equilibrium is
achieved, but pricing in the short run can reflect irrational exuberance during bull
markets or too much fear among investors during downturns.

Negative market returns mean that investors have been flocking to sell in the first half of
this year, and many of them will lock in real, permanent losses. More patient investors
will accept the paper losses as a temporary blip in a long-term uptrend and, if history
holds, will ultimately experience a recovery and no diminishment of their portfolios’
buying power.

Final Thoughts

Predicting what’s next on the horizon is a hazardous venture most of the time. Hopefully
the economy will continue to show resiliency that surprises the Fed and investors. It
may be that most of the damage to markets and the economy is behind us.

Our focus is to help you achieve your most important goals by participating prudently in
risk markets. Our process recognizes time as a key factor in investing and integrates
goal funding and investment strategy. Our desired outcome is to fund your needs
without having to recognize investment losses to do so. At the same time, we strive to
allow long term assets to stay invested through different market cycles so as not to
experience unnecessary opportunity costs.

In addition, we work diligently to identify potential silver linings. Bear markets create
valuable opportunities for some families to benefit from temporarily lower stock prices
(for example, those considering Roth conversions or currently holding excess cash
reserves or low basis stocks).

We are committed to providing you objectivity and steady guidance through both volatile
markets and euphoric markets – to give you the peace of mind to enjoy your life and
focus on what really matters most to you.

Filed Under: Current Perspectives

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Phone: (207) 775-1151 Email: info@harvestassetgroup.com
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