Macroeconomic View & Markets
As expected, for the first time since 2018, the Federal Reserve raised the Fed funds rate by 25 basis points (1/4 of 1%) to reduce consumer demand and slow inflation. There is too much money chasing too few goods, so prices are up across the board. Prices that consumers pay for goods, as measured by the Consumer Price Index or CPI for February, increased at 7.9% since February 2021. The CPI includes food and beverages, housing, clothes, transportation, and medical care, to name a few. So, the inflation rate for individual households depends on which of these are being consumed. Rate hikes by the Fed will continue throughout this year until inflation is closer to the Fed target. For now, the economy is robust despite somewhat higher but still low interest rates.
The sudden Ukraine war has also contributed to inflation due to the sanctions on Russian commodities such as oil, gas, and agricultural products. The Russian economy is largely being cut off by the rest of the world, which is reducing global supply and leading to higher prices for those goods.
A confluence of events throughout the quarter led to heightened market volatility, causing many short-term investors to sell. This led to the worst performance (January 1-mid-March 2022) in two years by the S&P 500 (-10%) and NASDAQ (-20%). However, both indexes rallied significantly after the mid-March lows, cutting losses by more than half. Even bonds sold off in anticipation of higher rates.
Overall, the economy is quite strong now. The unemployment rate is 3.6%, virtually back to the 3.5% pre-pandemic low. The U.S. added 400,00 or more jobs the past 11 months; 1.7M jobs since January 1, 2022. The job market is so robust that there are a record 5 million more job openings than are available, qualified workers. This shortage has led to higher wages to attract employees. (See Susan’s column.)
Initial jobless claims-166,000 (newly unemployed for the week ending April 2)-was the lowest since November 1968. The 4-week moving average is down to 170,000. Continuing jobless claims (long-term unemployed for the week ending March 26) increased by 17,000 to 1.523 million, a historic low.
In fact, 2021 ended with the economy growing (U.S. GDP) 6.9%, stronger than expected despite the Omicron variant spread and a pace that could not continue without rampant inflation. A slowdown from the pace of reopening after the pandemic shutdown is both needed and expected. The latest Q1 2022 GDP estimate is an annualized 1.5% (Atlanta GDPNow as of April 1).
This slowdown is the result of less fiscal support (checks to families and businesses) from Congress, a tighter Fed (higher interest rates and less bond buying), and continuing supply chain constraints (inability of plants to produce and deliver fast enough after being shut down for months). However, U.S. GDP is expected to pick up in the second half of the year and finish with an annualized rate of 3.5% because consumer spending is expected to remain strong and supply chain constraints are expected to ease.
As we have often written in these columns, predicting economic changes that are significant enough to turn markets negative is almost impossible. Similarly, selling during downturns to avoid a bottom is tricky, at best, since the bottom is known only in hindsight. Markets begin to move in anticipation of change. Often, they (sellers and buyers) have guessed wrong. Either the markets aren’t affected after all, or recovery has occurred by the time investors finally decide to buy back in at higher prices. Unless we anticipate a full-on recession, another global credit crisis, another technology bubble, etc., we plan to keep portfolios intact according to the models, making tactical adjustments along the way.
As always, when you have had an opportunity to review your Quarterly Report and this Commentary, contact us to schedule a review of your portfolio and any concerns or needs that you may have since our last discussion.
Fixed Income: returns on cash led for the quarter and 1-year. High yield corporates led in all other time periods. Cash was the worst performer in all other periods.
Equities: large U.S. stocks led for the quarter, real estate for the 1-year. Large-cap led all other time periods. Small U.S. stocks were the worst performers 1-year, while foreign was the laggard during the past 3, 5, 10, and 15-years.
Despite the recent market volatility, our outlook on equities is still positive. Even though economic risks are rising, the odds of a near-term U.S. recession (defined as 2 consecutive quarters of negative economic activity as seen in real GDP, real income, employment, industrial production, etc.) that are predicted in some headlines are still quite low. Estimates of earnings growth for 2022, which have risen throughout the quarter, remain around 9%. Unemployment is still falling. Balance sheets for both corporations and households are strong with elevated cash levels. We know that growth will be slowing, but slowing does not mean recession. The wild cards are whether the Ukraine war spreads beyond that country AND whether the Fed finds a Goldilocks rate increase path that will slow inflation without hurting the economy. According to UBS, which accurately predicted the current inflation rate while most other pundits disagreed, barring the wild cards, inflation is expected to peak this quarter and normalize by year-end at around 3.5%. There is no way to know what is going to happen on any of these fronts in the short term. As we have mentioned in the past few commentaries, we believe volatility will continue in politics, the global economies, and the markets. We remain cautious in our short-term outlook but positive on stocks for the long-term.