Inflation is Driving the Bus

As the markets closed the first quarter, one item of concern was above all others: inflation.  Persistently higher prices across nearly all categories is creating ripple effects that caused a pause in the strong markets seen since March 2020.  Markets were able to rally off the low point as March was a positive month for stocks.  However, March continued the trend of difficulty for bonds and the historical safe haven actually underperformed stocks during the first quarter of 2022.  As we look to the remainder of the year, the market will continue to grapple with higher prices, but the degree to which those prices accelerate or decelerate will be one of the key determinants of market direction. 

With regard to inflation, the US economy has prices rising at the fastest rate since the 1980’s.  The Consumer Price Index, a widely used measure of price change in the US, rose by 7.9% in February.  This high level of price increases is being felt across the board by US consumers: at the gas pump, at the grocery store, when they buy a vehicle and certainly when they buy a home.  As the Russian/Ukraine conflict escalated, this exacerbated price increases as Russia is a major energy supplier for the European Union. 

The ripple effects of rapidly rising prices can be felt in many areas.  First and foremost, the US Federal Reserve has shifted from supporting growth to controlling inflation.  The most widely known tool of the Fed is changing the Fed Funds Rate, which in March was raised for the first time since 2018.  Further, commentary from the Fed Governors, including Chairman Jerome Powell, gave suggestions that the Fed will continue on the path of raising interest rates at future meetings and potentially accelerate the levels more aggressively to curb inflation. 

The effects of an adjusting Fed can be seen in US Treasury rates.  The 2-year US Treasury rate rose from 0.73% at year end 2021 to close March at 2.28% while the 10-year US Treasury rate rose from 1.52% to 2.32%.2 As interest rates rise, bond prices fall.  Further, when bonds are producing very little income, there is little buffer to offset the price declines.  As we have been saying for some time, bonds simply are unattractive during periods of low rates that are expected to rise, and that is what we are facing now.  Bond markets, as measured by the iShares Barclays Aggregate ETF, actually underperformed stocks during the quarter.  Bonds and stocks both finishing a quarter negatively is a relatively rare occurrence and the last instance was the first quarter of 2018. 

The concern among stock investors is that rising prices, and subsequent actions by the Federal Reserve, will cause a significant slowing of economic growth and potentially a recession.  A widely looked at marker for potential future recession is an inversion of the yield curve, which simply means shorter term (2-yr) Treasury rates are higher than longer term (10-yr) rates.  A sustained inversion of the yield curve has typically preceded recessions, but the timing is fairly wide at anywhere from 6 to 24 months.  In March, the yield curve did invert for the first time since 2019. 

As we look to the remainder of the year, prices will remain the primary factor to watch.  Any reduction in the rate of inflation may induce the Fed to remain prudent and patient and reduce the potential of shocking the economy into recession.  However, a sustained level of highly elevated prices is negative for nearly all asset classes with the potential exception of gold and other commodities. 

Our outlook is still relatively positive on stocks.  Even though the probability of recession is rising, we feel that a recession in 2022 is still quite low.  Estimated earnings growth for 2022 remains around 9% this year3, and while markets are not cheap, valuations are lower than the elevated levels seen in the fall of 2021.  With regard to bonds, the rise in current rates means that new investors in bonds are actually receiving some level of income for their allocation.  While the level of income still significantly trails inflation, the absolute level of income is higher now than it has been since early 2020.  There are better opportunities in bonds now, coming off the worst quarter in the last 20 years4, but this wouldn’t be an area which we would be adjusting allocations aggressively. 

Lastly, volatility has made its way back into the markets after a relatively sanguine 2021.  Remember that volatility and uncertainty in the market is the norm, while times of high returns and low volatility tend to be the exception.  Expect markets to continue to be volatile in the near term as price concerns will likely remain with us for some time.  As always, stay invested for the long term and within the strategy set forth in your personal investment plan.  Safe assets have a place in portfolios to protect assets during times of volatility, but growth assets have a place to outpace long-term inflation and grow your overall asset base.  Keeping a proper balance of growth and safe assets to fit your personal objectives and within the barriers of your risk ability and tolerance remain the best way to achieve the goals for your money. 


To expand on these Market Commentaries or to discuss any of our investment portfolios, please do not hesitate to reach out to us at 775-674-2222

Posted on April 4, 2022 Read More

Geopolitical Risks Come to the Forefront

Markets faced a second straight month of declines as geopolitical fears combined with existing inflation concerns increased market volatility and led to a rise in fear-based selling.  Stock markets are now firmly in correction territory from the all-time highs seen on January 3rd, 2022. 

The main issues facing investors right now are increasing risk from rising prices (inflation) and geopolitical events (Russia/Ukraine conflict).  The issue is that these are somewhat correlated as well.  Because of the economic sanctions and restrictions imposed on Russia, as well as the continuing effect on Ukrainian exports, commodities such as wheat and oil may continue to rise in price.  This exacerbates the inflation already present in many goods and services due to high demand and limited supply.  When you combine these concerns with the near certainty of the US Federal Reserve increasing interest rates to combat inflation, there is question as to how much the US economy and consumers can handle. 

Despite these issues, not all the news in the markets has been bad – some news remains quite positive:

  • COVID cases, hospitalizations, and deaths are falling dramatically
  • Restrictions as a result of COVID are declining, which should begin to reduce supply constraints
  • Economic growth, employment, and the US consumer remain relatively healthy
  • The US has little to no reliance on Russian oil or gas
  • The majority of S&P 500 companies have reported earnings that exceeded expectations
  • Earnings growth projections for 2022 remain in the 8-10% range and companies are healthy

At the beginning of the year, we communicated that one of our caution flags for 2022 was the valuation of the market.  Simply put, stocks were expensive.  As a result of this correction, and the limited change to the fundamental forecasts, stocks are now cheaper than they were at the beginning of the year.  Now, could stocks continue to fall and get even cheaper?  Absolutely.  Stocks are coming down from elevated levels, but they still are not cheap.  Time will tell if valuations continue to decline for the markets, but the price paid for stocks is more reasonable now than three months ago. 

Another area we are seeing higher than average volatility is the bond market.  Bonds typically provide ballast against stock market declines as investors look to bonds for safety when stocks are not working.  This hasn’t been the case in 2022 as inflation and economic growth provide upside pressure to interest rates.  When interest rates rise, bond prices fall.  Furthering the difficulty in certain bonds is the elevated fear levels in the market, and investors during these times require higher premiums to take on default risk (called the credit spread).  At the end of the year, credit spreads were near all time lows as there was little evidence of economic concern.  Since that time, these spreads have been rising which also put pressure on bond prices. 

Overall, most traditional investments have been challenging in 2022.  Outside of precious metals like gold, there hasn’t been a lot of areas for investors to achieve positive returns year to date.  These trends don’t last forever but can be painful when we are going through them. 

These times are the most important to have a sound investment plan that incorporates both safety and growth assets.  Times of high volatility usually means greater positive and negative swings and increased emotion as a result.  Being concerned and emotional regarding investments is absolutely normal and should be expected.  However,  avoiding irrational action based on those emotions is the key to achieving your long term objectives. 

To expand on these Market Commentaries or to discuss any of our investment portfolios, please do not hesitate to reach out to us at 775-674-2222

Posted on March 2, 2022 Read More

Volatility Creates Opportunity

Markets stumbled out of the gate in 2022 after a very strong end to 2021.  In January, most global asset classes were down as the primary concern of investors transitioned from COVID to rising inflation.  While market corrections are unpleasant for stock investors, they are common over time and the volatility derived from a correction can create opportunities to add value over the long term.

The S&P 500 index declined by 5.17% as investor concerns around inflation and what the US Federal Reserve would have to do to curb inflationary prices created selling pressure on stocks.  NASDAQ stocks, which are more weighted toward growth technology and biotech, fared worse than the overall markets and had their worst January since 2008.  US small cap stocks and both international developed and emerging market stocks also faced declines for the month.

For the bond markets, interest rates were the primary detractor for the Barclays Aggregate Bond Index.  The 10-year US Treasury rate increased from 1.52% to 1.79% during the month, creating a headwind for bond prices.  This has been the general trend over the last year as the widely utilized bond index has had negative performance during that time. 

During stock market corrections, there is typically a wide swath of reasons provided for the price declines.  At no time in market history have there been zero concerns in the markets – it is simply a function of investing for an unknown and uncertain future.  The primary concern is now inflation.  We are at the highest levels of inflation since 1982 which has real consequences for the economy as companies have to pay more for employees and raw materials.  Those increased costs can also suppress the spending appetites of US consumers.  Higher inflation also tends to spur the Federal Reserve into action as one of their mandates is keeping inflation at controlled levels.  Currently we are well above their inflation threshold and, as a result, Fed commentary has transitioned from “if” to “when and how much” on the trajectory of rate increases.  The concern that comes from rate rises is the Fed becomes overly aggressive and chokes off the growth of the economy.

In our opinion, inflation and the Fed reaction are worth monitoring but are manageable risks.  We expect inflation to be elevated for the remainder of the year, but we see a path for deceleration in price growth in the summer.  Further, while the Fed is transitioning away from the support it has given the economy since COVID, it doesn’t automatically mean we are nearing the end of growth in the US economy.

When we examine the fundamentals, our stance is still relatively positive.  US consumers are healthy, have jobs, and their wages are rising.  Additionally, there is pent up demand for spending that hasn’t been fully unleashed yet due to continuing COVID cautiousness.  Companies are generally beating their earnings expectations, and growth is expected to continue at an above average pace despite the headwinds from rising prices.  Lastly, as a result of the recent correction, stock price valuations have come down.  Stocks are still not cheap, but the valuations for some companies have now come to levels where they are more attractive than they’ve been since the significant decline in 2020. 

Based on this data, our fundamental forecast and outlook has not changed.  We still expect bonds to have a challenging 2022 as we expect interest rates continue to rise throughout the year.  For the stock market, we still believe markets can work higher, but our expectation of higher volatility in 2022 has already come to fruition. Corrections are a normal part of investing and the relative calm of last year is the exception, not the rule.  Staying invested through the challenging times, and remaining nimble and flexible toward opportunities, remains the best approach to meeting the long-term objectives for your money. 

If it is a commentary: To expand on these Market Commentaries or to discuss any of our investment portfolios, please do not hesitate to reach out to us at 775-674-2222

Posted on February 2, 2022 Read More
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