Thoughts On Markets As We Head Into Spring

Spring Market Update

I’ve spent over thirty years investing money for clients and I can say that don’t remember a period where events have moved with the rapidity that I’ve seen since my last letter at the end of January.  I’ve attempted at least four times since then to write an update.  Each time events have prompted me to discard what I’d been trying to say.  I’m going to attempt one more time to share my thoughts even though this letter might be outdated by the time you receive it.  For brevity’s sake I’m going to put this correspondence out in a question-and-answer format that hopefully will cover the vast majority of issues I’m seeing and inquiries I’ve received from some of you.

What have been the main drivers of the crazy volatility we’ve seen in the markets this year?

Markets have been roiled by three things:  Covid and the supply chain disruptions it caused, the war in Ukraine the rapid rise of inflation and the Federal Reserve’s response to it.  First let’s deal with the continuing supply chain disruptions we’ve been experiencing since we first started locking the country down in 2020. These issues are slowly improving irrespective of the most recent news out of China and Covid has not been the main driver of events this year.  Virus restrictions were becoming a thing of the past.  A Federal Judge recently struck down Federal mask mandates regarding transportation. Most Americans are over Covid.  Politicians in fear of losing their jobs risk bringing back the lockdowns and restrictions of the past few years at their peril at this point. It likely will take a more lethal variant of the virus for these to even be contemplated in the future.  The most important issues have been the war in Ukraine and the Federal Reserve turning very hawkish on interest rates as they attempt to get a handle on the inflationary price shocks hitting consumers.

Which is bothering investors the most right now?

Currently, inflation and higher rates are probably the largest concern for most investors.  War, particularly any situation that could bring nuclear powers into conflict with each other is a serious issue, but for most investors and consumers the war is too far away.  I think the world was stunned when the war began as few likely thought the Russians would invade Ukraine.  Markets in February likely reacted negatively to what was going on over there.  But it is important to remember that markets are always looking towards the future.   Once it became apparent there was no easy victory to be had for Russia, then markets discounted the highest probable outcome and moved on.  That is investors have said it is unlikely that either side can now achieve a scenario that looks like an overwhelming battlefield victory so there will ultimately be some kind of negotiated settlement.  This isn’t meant to minimize the horrors of what’s going on in Ukraine, but to explain what the investment world thinks is the most likely scenario.  Markets are economic voting machines, not usually moral voting machines.  Markets see that the war has caused disruptions to the global economy but said economy will adjust.  Unless the fighting enters some new, more dangerous phase, investors believe they can currently parse out the final result, even it that outcome is months or perhaps years away.   Inflation and rising rates are currently bothering the markets more than the Russians.

Why is that? 

Investors, like consumers, know what they see.  What they are experiencing right now is higher prices for everything and not just small increases.  Anybody who’s been to the grocery store, a gasoline station or been out to a restaurant understand that prices for everything have increased at rates not seen since the 1970s.  The working class in particular is feeling this pinch.  It is true that wages have increased in the past two years, but a worker receiving a 8% increase in what he’s paid but paying 10% more for everything is losing money.  It is this kind of rampant inflation that the Federal Reserve is trying hard to curb.  

The main tool at the Fed’s disposal is raising interest rates and shrinking the Fed’s balance sheet.  Both activities serve to tighten money supply.  That in term is designed to slow the US economy which it is hoped will help curb this inflationary surge.  Right now, it looks as if the Federal Reserve is going to be more aggressive in raising rates than most investors originally assumed.  That is the main reason markets tumbled at the end of last week.  Higher interest rates can at some point make bonds more attractive on a yield adjusted basis than stocks.

 

How should we be thinking about this?

The current market environment has been called statistically the worst market ever for all asset classes.  Except for cash there’s been no place for investors to hide.  Longer dated bonds have declined at a rate that is largely unprecedented in the history of fixed income.  They are having their worst year so far in almost 40 years.  Major US indices are currently down on average between 12-20% with more growth-oriented areas of the markets being hit the worst. This is not great news.  But pull back the curtain a bit and you might gain a different perspective.  10-15% corrections are common in markets.  It’s just been a long time since we’ve had one of these.  This decline puts most of the major US indices roughly back where they where they were trading last summer.  Major growth-oriented indices in the US are now down closer to 20%.  That means we’re starting to get into ranges where value is being created in certain areas of the market.  

The main question at this time is how much have the markets discounted rising rates and the other issues concerning investors.  I cannot tell you at what price point markets will finally level out, but probability suggests we’re closer to that zone than we were a few weeks ago.  The overall markets created a bottom back in February that looks like it’s currently being tested.  A decisive break below those February low could cause us to become more defensive shorter-term in our investment posture.  However, I think the higher probability is that markets find their footing somewhere near those February lows and then remain range bound.  That is I believe stocks will trade up or down for the foreseeable future in a trendless manner, held hostage to current financial headlines.  Giving the kind of volatility we’ve seen these past few months, probability would suggest that trading range could vary by as much as perhaps 15% for the foreseeable future, at least until after the national Congressional and Senate races are resolved.

What’s the longer-term outlook?

A range bound market, one that slowly works off the excesses of the past few years, wouldn’t be such a bad thing as it would set the stage for the next rally.  Please note that even with these declines the average US market index is still up nearly 100% since the March 2020 lows.  As always, I carry a twelve-to-eighteen-month investment time horizon.  I continue to monitor client portfolios and am always on the lookout for value, either by adding to current  investments or by looking for new opportunities.  My preferred investment vehicle remains Exchange Traded Funds for all the reasons I’ve discussed in the past.  Out in that time range, things look a bit clearer and perhaps rosier than current market pundits would have you believe.  I’ve listed all the positive things the US has going for it in previous communications to you.  I’ll let you go back and read those letters for why I feel that way.  Nothing in our current situation regarding those longer-term positive economic fundamentals changes just because we’re going through a credit tightening cycle.  The war has the potential to change things up but for now it’s not the most important concern from an investment perspective.