Market Data for the quarter ended March 31, 2022:
- S&P 500 Stock Index: 4530, down 4.95%
- Ten-year Treasury Note Yield: 2.33%, up 0.82%
- Gold: $1,949 per ounce, up 6.6%
- Oil: $100 per barrel, up 33%
Stocks and bonds declined, while commodities rose in the first quarter of 2022 as inflation, the war in Ukraine, and uncertainty surrounding Federal Reserve monetary policy dominated market action. Even before Russia’s invasion of Ukraine sent commodity prices rocketing higher, investors’ chief concerns were elevated inflation and the US Federal Reserve’s efforts to bring it under control. As we begin the second quarter, these issues remain at the forefront of investors’ minds.
Our view is that despite the Fed having raised its benchmark overnight interest rate by .25% in March and signaling that six more such increases will be made in 2022, the Fed is still reluctant to decisively confront inflation. Given the powerful rally in risk assets we saw in the final two weeks of the first quarter, we would say this is a sentiment shared by the aggressive growth-oriented investors who have dominated the market recently. The Fed’s easy money policy of the past three years has been pure rocket fuel for speculation, and an “easy does it” effort to bring inflation under control is seen by growth investors as more of the same, ergo let the good times roll.
We take a different view and see the nonchalance of the Fed as a policy mistake. If their belief that a gradual and modest increase in overnight interest rates will be sufficient to bring down inflation is incorrect, they are setting up aggressive growth investors for a punishing bear market. We see this outcome as more likely than not.
Furthermore, an escalation in the Ukraine war could potentially lead to much higher energy prices and slower economic growth, i.e., the much feared “stagflation.” Such an escalation could take the form of a direct confrontation between Russian and NATO forces or Russia using biological, chemical, or nuclear weapons in Ukraine, thus leading to a full embargo on Russian energy exports. Presently, we do not see an economic recession in the US as imminent given the overwhelming strength of the employment market. However, a full-scale embargo on Russian energy exports would tip Europe into recession and increase energy prices sufficiently to smother consumer spending and corporate investment in the US.
Taken together, the risks presented by a potential Fed policy mistake and escalation in Ukraine lead us to expect muted returns and continued volatility in stocks and bonds for the remainder of 2022. Given the relatively conservative nature of your investments, we are confident that they will exhibit solid outperformance over the balance of the year, building upon their resilience in the first quarter. For bond investors, we hope the year’s volatility will present a greater number of opportunities to lock in attractive yields than were seen over the past two years.
Finally, a brief note on Covid. Barring the development of a drastically more virulent variant, we do not believe Covid will have a meaningful impact on either economic or market performance. Outside of China, the world has largely decided to “live with the virus” and move on.
For the remainder of 2022, we see the US stock market, as represented by the S&P 500 stock index, trading in a range of 4200 to 5000. It finished the first quarter at 4530.
As always, we appreciate your business and the continued confidence you have placed in us. Please do not hesitate to contact us with any questions or concerns you may have.