Both stocks and bonds struggled in the first quarter this year due to a more aggressive Fed posture, inflation risks continuing to increase, and the Russian invasion of Ukraine.
The US stock market experienced its first correction in almost two years as the Fed has steadily been increasing their rate hike expectations and discussing reducing their balance sheet as the year has progressed to try to slow down inflation, while the geopolitical risks from the war in Ukraine have only added further upside inflation risks.
The stock market began to improve throughout March, but still finished the quarter in negative territory. The bond market struggled in the first quarter with rate hike expectations increasing in a meaningful way with the Fed’s dot plot showing the potential for nine rate hikes this year.
At the beginning of the year, only three Fed rate hikes were projected by the Fed. This more aggressive Fed posturing has the market on high alert for a possible Fed policy mistake in the future if they were to overtighten causing a considerable slowdown in the economy.
Inflation continues to be the largest risk to the economy this year with a large supply and demand imbalance in many areas of the economy. The supply chain began to improve slightly early in the year prior to the Russian invasion of Ukraine. However, commodity prices including oil, natural gas, wheat and other commodities have increased due to the impact on supplies produced from both Russia and Ukraine further adding to the supply chain imbalances and adding upside pressure to energy costs throughout the globe, especially in Europe due to their large reliance on Russian oil and natural gas.
The Fed has taken a more aggressive posture to raise interest rates faster and begin to reduce their balance sheet this year, in an effort to slow the economy and stop inflation from becoming entrenched. It is too early to tell if the Fed will be successful in the efforts to slow inflation without causing too much of a meaningful slowdown in the economy.
The US is more insulated than Europe in terms of energy production so the US economy should be less impacted by inflated oil and gas prices. US GDP is projected to remain above trend this year; however, expectations have come down somewhat from the beginning of the year as inflation pressures begin to weigh on earnings expectations and consumer spending.
US companies have continued to show resilience in being able to pass along their increased input costs on to the consumer so earnings have continued to remain strong.
We will continue to monitor consumer spending throughout the year to determine if price increases begin to have a meaningful impact, which in turn will weigh on company earnings, especially companies that operate in the consumer discretionary sector.
US consumers have continued to show resilience in spending behavior in the face of higher costs, however the more entrenched inflation becomes, the higher the probability that consumer behaviors will eventually shift to a more cautious approach. The Fed has a difficult job ahead to try to rein in inflation, but not overtighten economic conditions to cause the economy to slow down too much.
While many positives remain for the global economy with global economic growth and company earnings expected to continue to remain positive in 2022, we maintain our view to be mindful of the risks that the markets face this year from a more aggressive Federal Reserve, elevated inflation, continued supply chain issues, and many different geo-political risks.
We recommend staying the course with your investment objectives, and we continue to rebalance and take profits as we see opportunities to protect portfolio gains and keep our portfolios in line with their investment objectives.
We also recommend communicating with us if any short-term cash needs arise so we can look for opportunities to be proactive when raising cash for any necessary distributions helping to protect against possible short-term negative moves in the market.
We recommend maintaining a more long-term focus on investment goals and objectives with an understanding that short-term headline risks rarely have a long-term effect on markets.