How bad has 2022 been for financial markets?

It cannot have escaped most people’s attention that the majority of global asset markets have had a difficult time lately. From a war in Ukraine, to rampant energy prices and inflation, as well as central banks hiking rates and talking of shrinking their balance sheets, not to mention fears of a recession, markets have had a lot to contend with.

If we look at the quarterly returns for global equities, going back to 1990, we see that the second quarter of 2022 ranks amongst the 10% worst. What makes the second quarter even more painful for investors is that bonds, which are traditionally a key building block of a diversified portfolio, have also suffered falls. This is not what we have come to expect, as for some time now bonds have come to the rescue when equities are weak.

The following table shows the largest quarterly falls for global equities, with the latest quarter being the only entry on the list where bonds have also suffered a negative return:

Source: Financial Express Analytics

When you consider that global equities and bonds also suffered falls in the first quarter of 2022, it means that this year a classic 60/40 portfolio of equities and bonds has suffered the third biggest fall over six months since 1990. The only time a 60/40 would have fallen more was in 1990, when Iraq invaded Kuwait, causing oil prices to spike and eventually resulting in a global recession, and in 2002, relating to the bursting of the tech bubble.

2022 also represents the worst first six months of a year for a 60/40 portfolio in over 30 years.

Source: Financial Express Analytics

Fortunately, there is some good news! Recent falls have left most asset markets on significantly better valuations, improving their expected future returns.

The yield on 10-year UK government bonds, which was essentially zero only two years ago, and still less than 1% at the start of the year, stood at a much healthier 2.23% by the end of the latest quarter. The 10-year US Treasury bond yield has also jumped from 1.51% to 3.01% over the first six months of 2022.

It is a similar story for equity markets. The price-to-earnings (P/E) ratio is a valuation measure that compares the price of a share to its earnings. When a P/E ratio is high it means that the stock/index is expensive. The converse is true when the P/E ratio is low. We can see that the P/E ratio for most major stock markets has fallen sharply this year. For example, the Forward P/E ratio of the MSCI World Index fell to 14.3 by the end of the June, compared to over 20 in early 2021. This gives us reassurance that the expected future returns from equities have also improved.

History also gives us some comfort when we look back at how a 60/40 portfolio has performed previously after suffering such a difficult six months. If we look at the ten worst six-month periods for equities, we see that on average the subsequent five-year return is 66.3%. This represents a significant improvement on the average for the other periods of 49.0%.

Source: Financial Express Analytics

Over the near term we expect volatility to remain high, as the negative headlines will not disappear quickly. However, over the longer term, we have plenty of reason to be optimistic that returns will be strong.

Mike Evans – Head of Portfolio Management