First Quarter 2022 Recap
Hello, Integrity clients and friends. Welcome to spring! In Colorado that means days of cold and possibly snow followed by days of sunshine. It is a volatile time of year for the weather. Nevertheless, we know that warmer days are ahead. Here at Integrity, spring means Integrity’s 11th Annual Golf Tournament is fast approaching on Tuesday, June 28th, 2022 at Flying Horse North. This year, with your help, we are supporting an exceptional organization in our community, Shield 616. Come join us. If you want to golf, sign up quickly. Golf slots will soon sell out.
You may agree that the weather isn’t the only thing that is volatile as we head into spring. To look at the headlines in 2022 you would think the world is coming to an end next week. U.S. inflation; Ukraine conflict; Global supply chain; Covid in China (again). All these events are serious and have certainly had an impact on market performance in 2022. Still, they are only part of the picture.
As usual, perspective helps. This time last year the S&P 500 index topped 4,000 for the first time ever on April 1, 2021… after a fairly tumultuous national election. Twelve months later, when the first quarter of 2022 came to a close, despite all the doom and gloom in the world the S&P 500 index was at 4,530 on March 31, 2022! That 13% increase may be a bit startling if you spend your day hanging around the gas station watching the price of fuel increase by the hour.
Presumably, no one likes paying more for things. Furthermore, the stock and bond markets have had a rough time of it in the first quarter of 2022. Stocks and bonds both lost 5%-6% in the quarter ending March 31. Yet the S&P 500 index recovered 7% in March while the world agonized over the invasion of Ukraine.
Nevertheless, let’s all take a collective deep breath and put things in perspective. By way of reminder, corporate profits are the key driver of the stock market and corporate earnings have been consistently strong to date despite the various challenges to corporate profits.
There are multiple issues impacting markets.
- The U.S. economy is strong, but there are also solid headwinds.
- Russia’s invasion of Ukraine, while first and foremost a humanitarian concern, will lead to further supply chain disruptions in an already fragile global economy.
- Inflation is high and the Federal Reserve’s measures will lead to higher interest rates.
Jamie Dimon, CEO of JP Morgan Chase, in his annual letter to shareholders assessed the situation well with the following (summarized) data points and comment.
In 2020 and 2021, the Federal Reserve took unprecedented steps to keep the economy healthy in the wake of the first Covid outbreak. Enormous amounts of Quantitative Easing (QE) were administered ($4.4 Trillion) coupled with enormous fiscal stimulus, which is always inflationary (approximately $5 Trillion). These numbers represent approximately 18% and 21% of 2021 Gross Domestic Product (GDP), respectively.Jamie Dimon
“It is easy to second-guess complex decisions after the fact. The Federal Reserve and the government did the right thing by taking bold dramatic actions following the misfortune unleashed by the pandemic. In hindsight, it worked. But also in hindsight, the medicine (fiscal spending and QE) was probably too much and lasted too long.”
The Feds actions in 2020 and 2021 along with other measures allowed the economy to grow 7% in 2021 despite continual headwinds from Covid, supply chain disruptions and labor shortages throughout the year. In 2021, the reopening of the economy, new vaccines, strong profit growth and artificially low interest rates fueled big gains in stocks.
But the winds have shifted in 2022. Inflation is a growing problem, oil and gasoline prices are up sharply, investors are grappling with the fallout of Russia’s invasion of Ukraine, and the Federal Reserve has pivoted away from its easy money policy.
However, as the table of returns below illustrates, the major averages have been quite resilient in the face of stiff headwinds. Credit the economic expansion and rising corporate profits. It’s not completely counterbalancing the negativity, but it has cushioned the downside.
Table 1: Key Index Returns as of 3/31/22
|Asset Class||Index||1st Quarter 2022||Last 12 months||Three Years (Ann.)|
|US Stocks||Russell 3000||-5.3%||11.9%||18.2%|
|Foreign Stocks – Developed World||MSCI EAFE||-5.8%||-1.6%||8.3%|
|Foreign Stocks – Emerging Markets||MSCI EM||-7.0%||-11.2%||5.2%|
|US High Quality Bonds||Bloomberg US Agg. Bond||-5.9%||-4.2%||1.7%|
|US High Yield Bonds||Bloomberg US Corporate High Yield||-4.8%||-0.7%||4.6%|
Source: Y Charts, Schwab, Russell 3000, Bloomberg
Stocks don’t move higher in a straight line. Volatility and corrections are to be expected, as we’ve discussed before in previous quarterly newsletters. Still, heightened uncertainty is not a cause for celebration, even if losses have been relatively modest.
Nevertheless, we see ebbs and flows in many areas. For example, millions of people retired early in 2020 and 2021 in part because of the fiscal stimulus offered by the Fed. However, now that inflation is upon us, many early retirees are reconsidering their decision and returning to the workforce. That is a welcome development to stem the labor shortages of 2021. (Bloomberg, 4/14/22)
At Integrity Wealth Advisors we don’t try to forecast when markets might correct. Instead, we make recommendations and individually craft portfolios based on several factors. Pullbacks are a normal part of investing. We will usually experience several corrections over the course of an economic expansion, but history says they are temporary.
Uncertainty generated by geopolitical events have rarely caused long-term damage to the major market indexes. But they do create short-term volatility.
The initial news of an event usually generates heightened uncertainty, which forces short-term traders to pull back. But if the crisis does not affect U.S. economic activity, investors typically incorporate the new normal into their outlook.
The situation in Ukraine seems to be following the historical pattern. What is happening in Ukraine is tragic, and how the war may unfold is a big unknown. Recently, there have been no significant developments that might negatively affect investor sentiment, and investors seem to be taking the apparent stalemate in stride.
It’s not that we are immune to the horrific acts of aggression by Russia. We’re not. But investors look at geopolitical affairs through a very narrow prism. That is, how will an event or events impact the economy?
Few see a cessation of hostilities in the near term. However, investors may slowly be growing accustomed to the daily reports coming out of Ukraine. It’s as if we are becoming comfortably uncomfortable with the war. Put another way, investors seem to slowly be incorporating a new normal into their collective outlook, as there hasn’t been a significant shock to demand for goods and services at home.
You may ask, “what about the surge in gasoline prices?” For starters, it’s painful every time we fill up. And it will translate into higher inflation. However, the broader economic impact is less certain. For every penny increase in the price of gasoline, U.S. consumer spending drops by $1.18 billion a year, according to an estimate from Federated Global Investment Management (Bloomberg). For example, a $0.75 jump in gasoline, if maintained over a year, would translate to less than 0.4% of GDP. It’s not insignificant, but by itself, it’s not enough to throw the economy into a recession.
Inflation and Interest Rates
Then there is the Federal Reserve. Its commentary has grown increasingly aggressive as it hopes to rein in inflation. At the March meeting, the Federal Reserve raised the fed funds rate by one-quarter of a percent to 0.25%–0.50%. And, as Fed Chief Jerome Powell has said, don’t discount the possibility of at least a half-percentage point rate hike (or hikes) at upcoming meetings. The Feds own Summary of Economic Projections suggests we may see a Fed funds rate of 1.75%–2.00% by year end. Others are predicting even more aggressive action by the Fed this year.
From an economic perspective, some are asking if the Fed can bring inflation back down without causing a recession. In past cycles, rate hikes were pre-emptive and proactively implemented to stave off any future jump in inflation. The Fed succeeded in engineering what’s called a soft landing in the mid-1980s and mid-1990s. Today, the Fed is reacting to higher inflation. It creates economic uncertainties that we will carefully monitor throughout the year.
Why are rate hikes important? Bond prices react inversely to interest rates. As interest rates go up, bond prices come down. Therefore, 2022 may be a difficult year for bonds already owned in a portfolio. However, for savers who want safe, interest-bearing investments, rate increases are good news because of the higher bond yields that follow.
For equity investors, it’s more problematic. When bond yields and interest rates are low (as they have been), bonds offer little competition to stocks. But rising rates and yields could encourage some investors to look at alternatives outside of equities. That is why a balance of both stocks and bonds in a well-diversified portfolio is important.
At Integrity Wealth Advisors, we believe in the long-term trajectory of both stocks and bonds. Corporations have proven resilient in the face of the pandemic and other headwinds. Corporate earnings have continued to grow despite the many challenges and we do not think that will stop anytime soon.
Furthermore, the U.S. consumer, who makes up the lion’s share (60%-70%) of U.S. GDP is in excellent financial shape with significant excess savings, thanks in part to past government stimulus. Consumers are eager to spend on travel, dining and other luxuries which were put on hold in 2020 and 2021, which will in turn drive corporate profits despite continual headwinds.
Finally, despite all our challenges, the United States remains the economic envy of the world. Our government isn’t perfect, maybe far from it, but the US dollar is still the world’s default currency and US treasuries remain the closest thing to a risk-free investment the world has.
Forward, with Caution
We at Integrity Wealth Advisors are cautiously optimistic that the economy will continue to grow as it has throughout the past few quarters; that consumers will continue to spend; and that the Fed will raise interest rates in a way that results in a soft landing for the largest economy in the world. It takes optimism in times of volatility to have faith, but history is on our side. There will continue to be rotations in portfolios over time (between stocks and bonds, growth and value, etc.) and, as always, we maintain that a well-diversified asset allocation will be critical to navigating the volatility.
I trust you’ve found this review to be educational and helpful. If you have any questions or would like to discuss any matters, please feel free to give me or any of my team members a call. On behalf of all of us at Integrity Wealth Advisors we are honored and humbled that you have given us the opportunity to serve as your financial advisor.