Quarterly Market Performance Commentary

Navigating the markets in 2022 has proven to be a challenge as a combination of factors has both elevated market volatility and sent the majority of asset classes spiraling downward. Of these factors, inflation continued to be a concern through the second quarter of 2022. With inflation reaching a 40-year high of 9.1% in June, more than 4 times the Federal Reserve’s goal of 2%, Chairman Jerome Powell has made it clear in multiple congressional hearings that the Central Bank is committed to cooling inflation. Those promises have turned to action as the Federal Reserve has now raised its benchmark federal-funds rate from near zero to a range between 1.5% and 1.75% through the second quarter of 2022 (see Figure 1 below).1

While rising interest rates may work to quell high inflation, it simultaneously increases pressure on the markets. The goal of the Federal Reserve is to find a “soft landing”, where inflation is reduced to a normal level without causing a recession. A recession is often defined as having two consecutive quarters of negative GDP growth. However, with the added complexities abroad including the Russian War in Ukraine, COVID-19-induced lockdowns overseas, computer chip shortages, and other supply chain-related issues, the risk of a recession is increasing. Jerome Powell stated that “The events of the last few months around the world have made it more difficult for us to achieve what we want.”2 However, while a recession is certainly undesirable, the larger potential issue in the eyes of the Federal Reserve is that inflation may not be as transitory as expected.

Figure 1: Effective Federal Funds Rate
Figure 1. Source: Effective Federal Funds Rate; New York Federal Reserve—https://www.newyorkfed.org/markets/reference-rates/effr

At this point in the economic cycle, there is a lot of speculation about whether the US will enter a recession. A senior economist at the Federal Reserve has placed the probability of a recession occurring over the next four quarters at 50%. Another survey of economists arrived at a likelihood of 44%.1 There is no perfect science behind these predictions, of course, and we anticipate all eyes will be on the movements of the Federal Reserve and inflation for the foreseeable future.

Domestic Equity and Fixed Income

Equity performance through the second quarter of 2022 continued its trend of high volatility with the S&P 500 returning -16.1% QTD (-20.0% YTD) and officially entering into a bear market in June (falling 20% from its January 3rd peak—see Figure 2 right).3 Second quarter market returns were hindered by a combination of factors. Russia’s War in Ukraine has continued to sharply increase energy prices due to global shortages, while also extending its influence to food prices as Ukraine is unable to export its usual sunflower seed oil, wheat, and corn.4 Additional supply chain issues are fueled by recent pandemic-related lockdowns in China along with a global chip shortage, which in turn have culminated in soaring inflation, causing central banks around the world to scramble to stabilize prices through a series of monetary policy changes.

Figure 2: S&P 500 Enters Bear Market
Figure 2. Source: The S&P 500 is Officially in a Bear Market. Here’s What to Know.– Caitlin Ostroff; The Wallstreet Journal

Sectors were down across the board during the second quarter. The worst performing sectors of the quarter include Consumer Discretionary -26.2%, Communication Services -20.7%, and Information Technology -20.2% QTD. Consumer Staples and Utilities, though still negative, fared the best falling –4.6% and -5.1% QTD respectively. Selected year-to-date sector returns can be seen in the chart above.

Bonds have continued to offer no relief to investors through the second quarter. Losses have persisted due to recent interest rate hikes and the expectation of potential future hikes. As a reminder, higher interest rates correlate to lower yields on bonds. The Bloomberg U.S. Aggregate bond index returned -4.7% in Q2.

Introduction to Inflation

Figure 3a. 12-Month Percentage Change CPI – All Items
Figure 3a. Source: 12-month percentage change; U.S. Bureau of Labor Statistics-https://www.bls.gov/charts/consumer-price-index/consumer-price-index-by-category-line-chart.htm
Figure 3b: Purchasing Power over 40 Years
Figure 3b. Data Source: CPI for All Urban Consumers 1982—2021; U.S. Labor Statistics—https://data.bls.gov/data

When inflation began to spike in Q2 2021, many officials claimed that it was “transitory”, implying that it would be temporary and short-lived. However, this has not been the case, and the term “transitory” was recently retired as inflation has shown its persistence for over a year. With inflation metrics making headlines day after day as a result of record high numbers over the past few decades (see Figure 3a left), it is important to understand what the term “inflation” means and how it affects the daily life of your employees and their retirement savings.

Inflation is the rate of increase in the overall price level over a given period. The rate of inflation is typically measured by the Consumer Price Index (“CPI”) which represents the price of a basket of commonly purchased items in the United States.

The CPI is the most common measurement of inflation in the United States and is calculated by the U.S. Bureau of Labor Statistics. In June, the “All Items” CPI set a 40-year-high measuring 9.1%.5

When the purchasing power of money erodes, there is a significant impact on the budget and day-to-day expenses for every American. However, what can be more challenging to visualize is the impact that this loss in purchasing power has on employees’ retirement savings.

If an employee’s retirement savings does not generate enough return to at least keep pace with inflation, employees will be losing purchasing power. Figure 3b (above) illustrates this concept with CPI data from 1982 to 2021. Money saved in 1982 needed to return a minimum return of 2.7% annually to keep pace with inflation through 2021. Retirement savers that preserved the value of their savings with no return on their investment have lost more than 50% of their purchasing power.

Other than keeping pay in line with rising inflation, what can plan sponsors do to help employees fight the silent eroding power of inflation? Education is key. Employees should be reassured that although the economy is experiencing a period of high inflation, this has happened before and the markets have always recovered. While many investors may try to time market events, such as inflation, history has shown that over the long-term, maintaining a well-diversified portfolio and staying the course can reward investors.

Cryptocurrency in Flux

While it is not uncommon to observe significant volatility in the cryptocurrency (“crypto”) market, Q2 2022 saw many cryptocurrencies in free fall as investors seek to unload riskier assets from their portfolios (see Figure 4). This past quarter saw the collapse of a pivotal stablecoin, terraUSD, which was designed to maintain the value of a dollar in the crypto ecosystem. Additionally, veteran crypto hedge fund, Three Arrows Capital Ltd., along with  large crypto-lending service, Celsius Network LLC., are reeling from significant losses.6

Fidelity Investments, one of the largest asset managers, broke ground this quarter when the company announced they would allow retirement plans to offer Bitcoin as an investment option in the future. This announcement came shortly after the Department of Labor expressed “serious concerns about the prudence” of plan sponsors and fiduciaries allowing retirement plan participants to invest in cryptocurrencies.7 The Employee Retirement Income Security Act of 1974 requires plan fiduciaries to act solely in the financial interests of plan participants and adhere to the standards of professional care in considering investment options for participants in retirement plans.

Figure 4: Total Crypto Market Cap.
Figure 4: Source: The Crypto Party is Over-Corrie Driebusch and Paul Vigna; The Wallstreet Journal

Many argue allowing crypto in retirement plans is not in the best interest of plan participants due to performance volatility, lack of historical data, higher expenses, recordkeeping complexities, and more. All eyes will be on Fidelity as they attempt to navigate regulators with this new offering.

Legislative Updates

For years, legislation surrounding retirement plans has lagged other political priorities, leading to out-of-date regulations that no longer fit the current American Workforce. Contrary to previous years, lawmakers have finally realized this and made it a priority to modernize retirement law. Year to date, there have been five new retirement-specific bills introduced in their respective chambers of Congress8, 9, 10, 11 (see Figure 5 right), with the Securing a Strong Retirement Act of 2022, dubbed the SECURE Act 2.0, being the only one progressing to the next stage in the lawmaking process.

Each bill appears to be written with a singular objective: to enhance the retirement saving experience for plan participants.  Some proposed provisions include expanding access to part-time employees, eliminating red tape for small businesses that want to offer retirement plans, and allowing employers to match student-loan repayments.

Figure 5: Legislative Progress Chart
Source: congress.gov

It is unlikely that any of these bills will pass on their own merit or in their current form. As the bills make their way through Congress, there will likely be amendments and reductions. The most likely scenario for any of these bills to pass and become law will be if they are included in a substantially larger piece of legislation. In any instance, if a bill were to pass, updates to your plan documents will typically be handled by your recordkeeper or third-party administrator, if applicable. Keep an eye out for communication from Forest Capital Management or your other retirement plan service providers for updates on the legislation front.

Fiduciary Training

In June, Forest Capital Management hosted a webinar focused on fiduciary responsibilities with our legal partners at Neal Gerber & Eisenberg LLP. This year alone, there have been numerous lawsuits targeting retirement plans and their fiduciaries, often citing excessive fees and improper management of plan assets. Plan sponsors and their fiduciaries can greatly mitigate these risks through diligent documentation of their decision-making process.

In addition to documentation, there are several steps a plan fiduciary can take to minimize litigation risks including regular review of plan documents, fiduciary training, plan compliance audits, investment and fee benchmarking, and vendor scope of service reviews. In any instance, regardless of how minute a plan conversation may seem, it is a best practice to document all decisions, even if that decision is to maintain the status quo.

Forest Capital Management regularly hosts webinars of this nature, but if you feel as though you would like additional training to further your fiduciary education, individualized training sessions can be requested. In the meantime, a recording of the fiduciary training webinar can be found here. If you have any questions, please do not hesitate to contact your Forest Capital Management advisor.

  1. Timiraos, Nick. “Fed Chair Jerome Powell Says Higher Interest Rates Could Cause a Recession” The Wallstreet Journal, 22 June. 2022, https://www.wsj.com/articles/powell-says-fed-needs-compelling-evidence-of-inflation-slowdown-to-alter-rate-rise-path-11655904616?mod=article_inline
  2. Timiraos, Nick and Fairless, Tom. “Powell Says Fed Must Accept Higher Recession Risk to Combat Inflation” The Wallstreet Journal, 29 June. 2022, https://www.wsj.com/articles/powell-says-pandemic-could-alter-inflation-dynamics-11656509259
  3. Ostroff, Caitlin. “The S&P 500 Is Officially in a Bear Market. Here’s What to Know.” The Wallstreet Journal, 13 June. 2022, https://www.wsj.com/articles/bear-market-explained-11652973167
  4. MacDonald, Alistair and Bariyo, Nicholas and Wen, Philip. “Rising Food Prices Roil Developing World” The Wallstreet Journal, 14 May. 2022, https://www.wsj.com/articles/rising-food-prices-roil-developing-world-11652520782
  5. “News Release Consumer Price Index—June 2022” Bureau of Labor Statistics, 13 July. 2022, https://www.bls.gov/news.release/pdf/cpi.pdf
  6. Driebusch, Corrie and Vigna, Paul. “The Crypto Party Is Over” The Wallstreet Journal, 18 June. 2022, https://www.wsj.com/articles/the-crypto-party-is-over-11655524807
  7. Jakab, Spencer. “Your 401(k) is Sagging. Bitcoin Won’t Fix it” The Wallstreet Journal, 17 June. 2022, https://www.wsj.com/articles/bitcoin-crypto-401-k-labor-department-11655424827?page=1
  8. “Open Executive Session to Consider the Enhancing American Retirement Now (EARN) Act: The United States Senate Committee on Finance.” United States Senate Committee On Finance, https://www.finance.senate.gov/hearings/open-executive-session-to-consider-the-enhancing-american-retirement-now-earn-act.
  9. Katz, Michael. “Reps Introduce Increasing Small Business Retirement Choices Act.” PLANADVISER, 6 May 2022, https://www.planadviser.com/reps-introduce-increasing-small-business-retirement-choices-act/.
  10. “Retirement-Focused Rise & Shine Act Clears Senate Help Committee.” PLANSPONSOR, https://www.plansponsor.com/retirement-focused-rise-shine-act-clears-senate-help-committee/.
  11. “Auto-Portability Legislation Introduced.” Ascensus LLC, https://www.ascensus.com/news/news-articles/auto-portability-legislation-introduced/.