Quarterly Market Review and Outlook
2022 Q1 Market Re-Cap
In our previous writing, we predicted heightened volatility in 2022. Nobody’s crystal ball is perfect, but our expectations were more than met!
The S&P 500 index went as low as 4157 in early March—this represented a decline of 14% since January 1.i The technology focused NASDAQ entered Bear Market territory and by mid-March was down over 20%.ii International stock markets (as measured by ACWX) joined in the party and were down 14% at one point during the quarter.iii
At least for the time being, U.S. markets have appeared to stabilize and have regained some of their lost ground. The S&P 500 is down almost 5% for the first quarter of 2022.iv The NASDAQ finished the quarter with a decline of approximately 10%.v
While stocks have been volatile, we would argue that the bond market has done even worse on a relative basis. The broad U.S. bond market (as measured by AGG) is down almost 6% during the first quarter.vi
That is the bond markets worst quarterly performance since 1980.vii The international bond market did no better and was down approximately 5% for the quarter.viii
There are several reasons that the Global stock and bond markets have been volatile this year to include inflation, interest rate increases, and geopolitical issues.
2022 Q2 Outlook & Beyond
Inflation & the Federal Reserve’s Problem
As we have written over the past few quarters, inflation continues to be concerning. The personal consumption expenditure (PCE) price index is up 8.8% year-over-year. The U.S. has not seen this level of inflation in 40 years and it can be downright scary. The Federal Open Market Committee forecasts the current numbers will settle in the 4.1% to 4.7% range later this year and 2.3% to 3% next year. If that proves to be true, the numbers over the next several years will fall within historical norms—we will see how this develops in the coming months and quarters. It may get slightly worse before it gets better.
There are several culprits that have driven our current inflationary cycle.
In his recent piece “We Are All Keynesians Now”, Brian Wesbury outlines the economic theory of John Maynard Keynes. He supported government deficit spending and government manipulation of the economy. These policies were first implemented in the U.S. in the late 60’s and early 70’s. Many believe these policies led to the economic stagflation (slow growth and high inflation) the U.S. experienced in the late 70’s and early 80’s with both unemployment and inflation peaking in the double digits.
That blueprint of Keynesian policy response was used in the aftermath of our COVID shutdowns. Since then, the Federal Government borrowed at least $5 trillion to spend and the Federal Reserve Board increased its balance sheet by over $4.5 trillion. Agree or not on the politics of this, but when too much money is chasing too few goods, you have inflation.
The second issue contributing to inflation is the so-called supply chain disruptions. Simply put, we are dependent on China for many of the goods that we rely on—that is unfortunate but a fact. The current average time for a shipping container to clear a U.S. port from a factory in China is 109 days—historically, it is less than half that time.ix If something is scarce or not available, the price goes up. Have you tried to buy a truck lately? If you can find one, the price is very high.
Third, in our opinion, the Federal Reserve made a mistake in not beginning a normalization process at some point in 2021—in other words, we think they are late in raising interest rates. They asserted frequently last year that inflation would be transitory. It’s now obvious that isn’t the case. Raising rates is one of the primary tools at the Fed’s disposal to fight inflation. In an attempt to catch up, the Fed Funds Futures are projecting a .50% interest rate increase in both May and June meetings.x Additionally, projections are suggesting that the Fed Funds rate will be 2.5% by year end.xi If the Federal Reserve moves the Fed Funds Rate from 0% to 2.5% this year that will represent the fastest interest rate hike by percentage since the 1950s.xii
U.S. Stock Market
If you recall either from recent conversations or from the previous newsletter, we felt strongly that the U.S. stock market went into 2022 on solid footing, but a bit overvalued and ripe for a pullback. During the first quarter, we generally held more cash than in previous years—that helped insulate from some of the volatility. As counterintuitive as it may sound, periodic corrections can be a good thing. It allows markets to reset after a prolonged positive run and restores value to overpriced sectors of the market. Second, it provides an opportunity to selectively pick up bargains—if you have “dry powder.”
Based on our writings on inflation above, you can easily assume the stock market is in for trouble this year.
This, however, doesn’t take into consideration the full reopening of the U.S. economy. It is clear that very
generous pandemic unemployment benefits had a massive impact on employment. Those choosing not to work thought “Build Back Better” would keep those checks coming. Now, with BBB dead, some of those people have headed back to work. In the first quarter, 1.69 million jobs have been filled. This year, the projection is 4 million people will rejoin the work force.
Also, U.S. 1st quarter corporate earnings were strong with over 80% of the S&P 500 reporting earnings exceeding estimates.xiii Additionally, the U.S. banking system appears to be significantly stronger than before the 2009 economic crisis.xiv Finally, we would suggest that while the U.S. stock market is certainly not perfect and likely to continue to experience bouts of volatility, there are few attractive alternative places to invest money currently so demand for U.S. stocks is likely to stay high.
In short, we believe, there is a lot of underlying strength in the economy and we think that U.S. stocks have the opportunity to move higher by years end. Unless something changes, we intend to use periods of market weakness to deploy cash we are holding to selectively increase exposure to equities.
We do have strong feelings about where money is best invested in the stock market. We think active
management as opposed to indexing is smart now and that stock and sector selection are key. We continue to favor value over growth. We think owning quality companies is smart and we are shying away from speculative stocks. We like the U.S. over international markets. We don’t necessarily have a preference for large cap versus small cap but our desire to hold quality causes us to drift towards the large, “bluer chip” end of the market.
Geopolitical Issues
Like most people we find the Russian invasion of the Ukraine to be reprehensible. It seems obvious that Russian President Vladimir Putin wishes to reassert control over at least one country in the former Soviet block and it does not appear that he cares about the economic or human costs to the people of the Ukraine or Russia.
As we have no inside knowledge on intelligence matters, it is impossible for us to say where this invasion goes. From an economic perspective, we all know the short-term impact on energy costs. Obviously, if the invasion escalates into other countries, specifically NATO countries, or nuclear weapons are used, then we would expect all financial markets to react very negatively. Based on what we can find to read, it doesn’t appear either scenario is likely.
In terms of the economic impact on the U.S., the obvious thing to point to is the effect on oil and energy prices. Prices were already up substantially when compared to several years ago. The Administration seems to believe the way out of this is to increase and accelerate our move to “clean and renewable” energy. Our view is this will only exacerbate the short-term problem and that the focus should be on increasing production of U.S. oil and natural gas. Not only could this help us regain our energy independence, but we could again become a net exporter to other countries to include liquid natural gas to Europe—this would certainly give a boost our economy. It has been said many times—elections have consequences, and we have an important one in November. As quickly as our energy independence disappeared, with the proper leadership, it can be regained.
Summary
With high inflation and geopolitical instability, there can be a lot of reasons to be negative about the U.S.
economy. As we said earlier, we believe it has underlying strength.
We spend almost no time these days hearing about COVID. It is our understanding that Spartanburg Regional currently has zero COVID patients in the hospital. We give thanks to God for that.
We will continue to encourage clients to not react emotionally to the news events of the day—emotions often betray facts and cloud judgement. Our job is to help access risk and make recommendations based on your unique circumstances. That process involves taking into consideration your situation and your goals and objectives.
We will be watching very carefully in the coming weeks and months and will respond accordingly as
circumstances change.
As always, we want to thank you for your trust and confidence—we take that very seriously and hope to earn that with every conversation. If we can be of any service to you or your family, please let us know.
We hope that you and your family have a glorious Easter!
i https://finance.yahoo.com/quote/%5EGSPC?p=%5EGSPC
ii https://finance.yahoo.com/quote/%5EIXIC/history?p=%5EIXIC
iii https://finance.yahoo.com/quote/ACWX/history?p=ACWX
iv https://finance.yahoo.com/quote/%5EGSPC/history?p=%5EGSPC
v https://finance.yahoo.com/quote/ACWX/history?p=ACWX
vi https://finance.yahoo.com/quote/AGG/history?p=AGG
vii Goldfarb, Sam. “Bond Market Suffers Worst Quarter in Decades.” The Wall Street Journal. 31 March 2022. https://www.wsj.com/articles/bond-market-suffersworst-quarter-in-decades-11648737087?siteid=yhoof2&yptr=yahoo
viii https://www.morningstar.com/etfs/bats/iagg/performance
ix “The Kiplinger Letter: Forecasts for Executives and Investors”. 1100 13th Street NW, Washington, DC 20005. Volume 99, Number 12. 24 March 2022.
x https://www.cmegroup.com/trading/interest-rates/countdown-to-fomc.html?redirect=/trading/interest-rates/fed-funds.html
xi Ibid.
xii https://www.macrotrends.net/2015/fed-funds-rate-historical-chart
xiii Brinker, Bob. “Bob Brinker’s Marketimer®”. Volume 37, Number 3. 4 March 2022. www.bobbrinker.com.
xiv https://www.federalreserve.gov/newsevents/pressreleases/bcreg20210624a.htm
Securities offered through First Heartland Capital ®, Inc., member FINRA/SIPC. Advisory Services offered through First Heartland ® Consultants, Inc. Walker, Higgins & Associates, LLC and Walker, Higgins & Associates Wealth Management, LLC are independent of First Heartland Capital ®, Inc. and First Heartland ® Consultants, Inc.