Rising Rates and Threat of War
Published March 2022
I find it very difficult not to be overly negative in this writing! In previous writings, for nearly 18 months, we have voiced our opinion that inflation was not only present, but would endure for some time. In February, the Department of Labor reported that consumer prices jumped 7.5% versus the previous year. The acceleration in prices ranged across many areas, from food to furniture to rents, airline fares, and electricity.
I dwell on a recent story that I heard from a banker about trying to wrap up a real estate development that one of his clients was doing. He mentioned that building material prices were changing so rapidly over the past several months that the developer could not complete his agreement without the builder wanting some built-in protection in case prices continued to escalate. That caused such a lengthy delay that the bank could no longer guarantee the interest rate on the deal (because rates, too, were quickly moving higher). The developer had outside investors that had suddenly become concerned about economic conditions and were waffling on whether or not they wanted to participate. Somehow and some way, all parties got together and finalized the development. All I could think about was that this is exactly what occurs when both interest rates and inflation are increasing quickly. Uncertainty of cost and profit rules the day and a solid deal suddenly turns into a deal that might not happen at all, and economic activity slows.
Thus far in 2022, there is one asset class that is up for the year: Commodities (energy, ag, and metals). The only stock sector that is positive is energy, and it is up in a major way. Small growth stocks as a group have dropped over 30% since their peak in November. A few popular growth stocks and their returns from their 2021 highs are Tesla down 40%, Netflix down 52%, Amazon down at one point 28%, Facebook/Meta down 48%, and Zoom Media down 75%. When growth stocks quit growing as rapidly as they have in the past, they have been historically punished and this time has been no different.
At the time of this writing, the S&P 500 is down about 12% in 2022. For well over a year, we have been very vocal in our preference for smaller stocks, and stocks that are oriented toward value and dividends. Our most widely held high dividend ETFs, SPYD and HDV, have outperformed the S&P 500 by nearly 15% this year. We think that story will continue, as those areas do best during times of inflation and rising rates.
The market does pretty well when there is stimulus being provided by Congress or the Fed. But when Congress stops lavishing money upon the masses, or the Fed begins to tighten, the market usually gets difficult as the yield curve flattens or inverts. One Wall Street firm said this week that they expect 11 rates hikes by the Fed in 2022 and 2023. That would take the current 0.25% Fed funds rate up to or over 3.0%. The last time the rate was that high was just before the financial crisis in early 2008.
The market impact of the Russian invasion of Ukraine has been substantial. Commodity prices, defense, and energy stocks all spiked, emerging markets declined, investors flew into gold, and the overall market sold off. Typically war times increase spending, which eventually leads to economic expansion. But before the expansion usually comes a time when people hoard their money and can’t or won’t travel, and economies slow quickly. That may be occurring in Europe. Hopefully it will not spread to the Americas. I find it hard to believe that 150,000 foreign troops could take over 44 million Americans (population of Ukraine), and it seems they are finding it difficult to do in Ukraine. You go Ukraine!!!
One bright spot continues to be the U.S. consumer. With household balance sheets still looking strong, and wages improving, sectors such as retail, automotive, and housing all seem to be marching along well. Let’s hope inflation doesn’t slow this tremendously.
We will remain diligent in our duty to prudently manage your portfolios during these times. The market gets very rocky during and after times when the Fed pulls in the reins on the economy. We believe that the rest of 2022 will continue to be volatile. Though the markets may be bumpy, we are more intently focused on you reaching your long term goals, and will keep that in mind above all when making decisions for you.
To rosier days ahead!
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