The second quarter of 2022 has continued the trends from the first, with the headlines being dominated by the same three global macroeconomic factors; inflation and interest rates, the ongoing war in Ukraine and China’s Covid strategy.

The combination of these three factors has knocked investor sentiment so far this year and asset prices have fallen. However, it is also important to remember that markets move in anticipation of events and the returns this year in global bond and equity markets have meant a lot of bad news is already reflected in asset prices.

Inflationary pressures were already building as we came into 2022; a factor of economies reopening and demand being strong. Russia’s invasion of Ukraine only acted to turbo charge commodity prices to fresh highs with everything from food to energy being impacted. This has meant that we are seeing eye watering inflation across all developed markets. In the UK, consumer price inflation has reached 9.1%. Subsequently, we have seen two key responses from this data; rising interest rates and the growing risk of recession. The first, faster than expected interest rate increases are a function of the fact that central bankers have inflation targets of 2% and they have therefore been forced to act more aggressively than they would have liked. We have been in an environment of cheap money for a decade and that ship has turned. The second, is the fear that these inflation figures have on the consumer with the knock-on impact that the economy will slow and we enter a recession. The risks of this have certainly increased but it is not a certainty at this stage. If economic growth is lower, then company earnings will follow suit and share prices have adjusted lower in expectation of this.

The themes of what has been driving markets in the first quarter has continued into the specific global stocks markets. Of the ten main global indices the FTSE 100 is the best performing market even though it has delivered a marginal negative return. This is mainly due to the heavy weighting towards oil and mining companies which continue to benefit from soaring commodity prices.

Reasons to be optimistic? Historical record shows that terrible first halves to the year are typically followed by a strong

bounce back in the six months that follow. If inflation starts to ease, if employment stays robust even as real wages fall, and if the war comes to a quicker than expected end, that should be the story of 2022 as well. It is unlikely to be a great year but a lot of the losses of the last six months could be quickly recouped.

According to LPL Research, the S&P 500 has been down by 15% or more in the first half of the year on six occasions since 1930. On each of those six occasions, the second half of the year showed a strong bounce back with an average gain of 22%. 1932 holds the record of the worst first half and best second half with a 45% drop followed by a 56% recovery. There are some other interesting periods to analyse; in 1970, the S&P fell by 21% in the first half of the year, rattled by the early signs of the stagflation, but then rose by 26% in the following six months. In 1962, the market fell by 26% between January and July (the Cuban missile crisis) followed by a 15% bounce. The explanation is slightly different each time. But the pattern is clear. A rapid second-half recovery can follow a terrible opening.

In summary, the headlines are horrible. The cost of living crisis seems to be mentioned in the press on a daily basis. However, please remember that a lot of this has been reflected into asset prices already. Markets are forward looking. We appreciate the current periods of short term volatility are uncomfortable but Luna is sticking to our approach which will stand the test of time; picking good quality investments for the long term.

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