Midyear Outlook: What should you do next?

A woman uses a handrail in climbing a wooden ramp by an ocean cliff.

Given high inflation, volatile markets, and slowing growth, investors are uncertain about how to respond. Darrell Cronk offers thoughts for the months ahead.

Darrell Cronk
Darrell L. Cronk, CFA;
President, Wells Fargo Investment Institute;
Chief Investment Officer, Wealth & Investment Management

To paraphrase American Revolutionary Thomas Paine, these are the times that try investors’ souls. After the S&P 500 Index delivered exceptional performance by registering annual returns of 28.9% in 2019, 16.3% in 2020, and 26.9% in 2021, 2022 has proven to be the worst combined start for financial markets since the 1930s.

Why the shift? There’s stubbornly high inflation — no surprise to those who have shopped for a car lately, tried to rent an apartment or buy a home, frequented the grocery store, or bought an airline ticket. Inflation is not only a problem for the consumer; if you are in business making virtually anything and your transportation costs have spiked, your labor costs are soaring, and the cost of your raw materials have gone up 20% to 30% in the past year, you may be wondering how fast you can increase prices of your goods to simply maintain the same margins and earnings power.

The Federal Reserve (Fed) has responded by initiating an aggressive series of federal funds rate hikes aimed at taming inflation, and markets expect more to come. This begs the question: Can the Fed slow inflation faster than it slows the economy and without triggering a contraction in growth and the next recession?

In the face of this uncertainty, we’ve seen the markets do what they do — be efficient, forward-looking, discounting machines that clearly see the slowing growth and tighter policy on the horizon. They correct, sell off, and ultimately convulse to a bottom. This has been a natural part of any and every economic and market cycle.

To be clear, markets have risen every time they have fallen in the past, and we unequivocally believe they will rise again. The question really comes down to this — over what time horizon? The key is to not fear what may happen in the meantime but to position for it and have portfolios ready for the eventual recovery that has historically come on the other side of the repricing.

To be clear, markets have risen every time they have fallen in the past, and we unequivocally believe they will rise again.

For help with determining what you may want to do with your portfolio, I recommend our “2022 Midyear Outlook: Faster, Further, and Fragile” report from the team at Wells Fargo Investment Institute. It strives to help investors make sound decisions while facing the unknowns of the remainder of this year and beyond with a focus on:

Economy. We believe the economy likely will enter a mild, and short-lived, recession at the end of 2022 and early 2023.

Fixed income. We expect market volatility and uncertainty to continue while inflation persists and the Fed steps up its pace of rate hikes. We favor playing defense in fixed-income portfolios. While interest rates continue to rise moderately, we favor short-term maturities and municipal securities.

Equities. We expect earnings to weaken through 2023 as revenue growth moderates and operating margins contract from record levels. We favor high-quality U.S. large-cap and mid-cap equities and have upgraded the defensive sectors Consumer Staples and Utilities, which have historically performed better late in the economic cycle, while downgrading the cyclical sector Consumer Discretionary.

Real assets. While 2022’s first half witnessed record commodity prices due to supply shortages, we suspect that slowing demand may be the more influential factor in the second half of 2022 and into 2023. We expect commodity prices to begin gradually increasing again, led by energy and precious metals.

Alternative investments. For qualified investors, late-cycle is an opportune time to allocate to alternative investment strategies that have low correlation to equities and fixed income. We favor Macro and Relative Value, but investors should be prepared to add Event Driven as we approach a recession.

For more on our guidance and our top five portfolio ideas for the second half, download the report.

Wells Fargo Investment Institute, Inc. is a registered investment adviser and wholly owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.

All investing involves risks including the possible loss of principal. Past performance is no guarantee of future results.

Stocks may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors.

Bonds are subject to interest rate, credit/default, liquidity, inflation, and other risks. Prices tend to be inversely affected by changes in interest rates.

The commodities markets are considered speculative, carry substantial risks, and have experienced periods of extreme volatility. Investing in a volatile and uncertain commodities market may cause a portfolio to rapidly increase or decrease in value, which may result in greater share price volatility.

Alternative investments carry specific investor qualifications, which can include high income and net-worth requirements as well as relatively high investment minimums. They are complex investment vehicles, which generally have high costs and substantial risks. The high expenses often associated with these investments must be offset by trading profits and other income. They tend to be more volatile than other types of investments and present an increased risk of investment loss. There may also be a lack of transparency as to the underlying assets. Other risks may apply as well, depending on the specific investment product.