The pandemic and now the war in Ukraine have had tremendous impacts on the markets. Years of supply disruptions and a declining workforce have substantially decreased the supply of goods, while a strong consumer and government stimulus have led to high levels of demand. Together, this has caused the highest levels of inflation since the 1980s. While market returns over the last few years have been good, the emotional toll of loss from these events is draining. We believe it is important to dissect the various factors influencing the markets to gauge where we are headed. Uncertainty is high, which we expect will lead to volatility and opportunity along the way.
First, let’s start with the good. Although we have recently seen some spikes in COVID cases around the world, for the time being, it appears to be under control here in the U.S. The Omicron variant produced average daily cases of over 800,000 in Dec/Jan. Today, average new cases are around 32,000 which is a drastic improvement from where we were just a few months ago.
The unemployment rate is now down to 3.6% after spiking up to 14.7% in April of 2020 and there are currently more jobs available than workers to fill them. Economists are predicting the unemployment rate could fall to 3.1% as wages continue to rise whih could entice more people back to the workforce.
We are heading into earnings season and analysts still expect strong earnings growth from companies for the first quarter. Earnings are the basis for how stock prices are determined so fundamentally that will be key in maintaining stock values.
Now, for the not so good.
Inflation hit 8.5% year-over-year in March of 2022. This was the highest inflation reading since 1981. Broadly speaking, prices are determined on the basis of supply and demand. Supply for many goods have been cut by COVID shutdowns, which continue today in parts of China. Compounding this issue, the war in Ukraine and resulting sanctions has cut the supply of oil, natural gas, fertilizers, wheat, and other important commodities. The Fed has begun raising interest rates to decrease demand to try and drive down inflation. If the price to borrow money increases, then eventually the demand for those goods should decline which will lead to lower inflation. The big question is how aggressive the Fed will be. If they raise interest rates too quickly, they risk sending the economy into a recession with slower growth ahead. If they are too slow, we could continue to see high levels of inflation drag on.
The bond market expects the Fed to act aggressively and has already priced that in. The bond market is experiencing the worst year-over-year return in the 40+ year history of the Bloomberg Aggregate Bond Index. Bond prices are down about 8.5% this year. Bond prices coincide with interest rates and as interest rates stabilize, we expect bond values to recover. This is short-term pain for higher interest rates and better yields in the future.
Did you know?
Bonds are loans made to corporations and governments. Bonds represent a commitment by the borrower to pay back the amount borrowed plus interest. If the borrower doesn’t pay the money back with interest, bondholders are first in line to recoup proceeds from the sale of assets owned by the company/government. Bonds have two components – principal and interest. When interest rates rise (like they are now), the principal component declines temporarily until the bonds mature. At maturity, the full principal amount is returned and can then be invested at higher rates.
Our hearts and prayers go out for the people of Ukraine. The longer the war there drags on, the more severe the impacts are for the economy and supply chains, and most importantly, the loss of human life.
With overall economic uncertainty so high, we believe it is prudent to be more defensive in our discretionary portfolios. We have been careful to maintain positions in stocks we think have the greatest potential for growth in the future, while reducing our risk level overall given the high level of volatility we expect in the future. We continue to believe in broad diversification to best meet your financial goals. A peace treaty in Ukraine, declining inflation, and a more accommodating Federal Reserve are all things that could happen that could send stock prices higher in the short term. For those reasons and for long-term growth, we don’t intend to abandon stocks in our portfolios, but we do believe it is wise to be more conservative at this time.
We appreciate the trust you’ve placed in us to help you navigate the markets. If you’d like to discuss your personal investments outside of your normally scheduled review, please don’t hesitate to reach out.
Congratulations to Reta! Reta retired in March and we couldn’t be happier for her to reach that Milestone! We are sad to see her leave, but excited to see where retirement takes her!
We’ve hired Kelly Cannone as our new office manager in Macungie. Kelly has over 20 years of experience in the finance industry and is off to a tremendous start. We are excited for you to meet her!
Earlier this year we also added two more financial advisors, Jeff Lanscek and Emily Moore. Jeff is working out of the Bethlehem office and Emily is in Macungie.