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Review the latest portfolio strategy commentary from Mike Gibbs, managing director of Equity Portfolio and Technical Strategy.

Short-Term Summary:

The first half of 2022 is coming to a close with the S&P 500 in a bear market and down ~21% year-to-date. The year was expected to be marked by a normalization of economic and earnings growth, valuation, and returns as the Fed ended its unprecedented level of monetary stimulus out of the Covid shutdown. But volatility intensified with inflation reaching 40-year highs, contributed greatly by the Russia/Ukraine war and China’s zero-tolerance Covid policy. Stubbornly high inflation is putting increasingly more pressure on consumer disposable income and corporate margins- and complicating the Fed’s objective of bringing inflation to a more comfortable level within a slowing economic backdrop. For example, the expected fed funds rate by December has risen to 3.4% from 0.8% when the year began.

Ultimately, convincing improvement on inflation is what is needed to ease strains through the broad market. A durable bottom in stocks likely comes in conjunction with a peak in oil prices, inflation, and bond yields. There has been some progress lately as the sharp uptrend in commodities and bond yields has subsided a bit, but it may be premature to call a definitive top in them yet. Accordingly, we have seen positives on the underlying drivers of inflation, but a moderation from lofty levels is likely to take some time.

Over the next 12 months, we do expect inflation to moderate and for equities to be higher than current levels. Though not necessarily at “wash out” levels, valuation has become very compelling for many stocks- resulting in opportunity for long-term investors. But the shorter-term (weeks to months) is likely to remain challenged with additional weakness. The predominant market trend remains lower for now, leadership continues to skew defensively, and market indicators such as CDS spreads have yet to improve. And it may take some time for equities to ultimately climb out of the current weakness. The potential for a sharp V-bottom back to the old highs is low in the current environment due to high inflation- we do not have the luxury of the Fed coming to the rescue yet (like the quick dovish pivots out of the 2018 trade war and 2020 Covid shutdown).

With this in mind, we continue to err on the side of caution in the shorter-term. But recommend long-term investors use the market downdrafts as opportunity to accumulate high quality, favored names for the inevitable recovery on the other side of this bear market.

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Index Definitions

The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market.

The Dow Jones Industrial Average (DJIA) is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange (NYSE) and the NASDAQ.

The NASDAQ Composite is a stock market index of the common stocks and similar securities listed on the NASDAQ stock market.

The MSCI World All Cap Index captures large, mid, small and micro-cap representation across 23 Developed Markets (DM) countries. With 11,732 constituents, the index is comprehensive, covering approximately 99% of the free float-adjusted market capitalization in each country.

MSCI EAFE (Europe, Australasia, and Far East) is a free float-adjusted market capitalization index that is designed to measure developed market equity performance, excluding the United States & Canada. The EAFE consists of the country indices of 21 developed nations.

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