Last week, markets temporarily bounced, defying many risks circling the economy and financial markets. Those risks included (1) Higher Inflation, (2) Higher Interest Rates, (3) Less Fiscal Support, (4) Slowing Economic Growth, and (5) Russia/Ukraine Tensions. In today’s monthly update, we dive into each of these risks.
- Higher Inflation
Inflationary pressures continue to mount as the economy deals with supply chain issues, worker shortages, and commodity price increases. It’s been over 50 years since the economy dealt with an inflation rate north of 7%.
However, many older investors can remember the times of the 1970s, which brought the oil crisis, Watergate, wage and price controls, and the end of the gold standard. Today’s inflationary pressures provide different dynamics.
The main difference is quite apparent, but the pandemic created significant economic dislocations. With the onset of the pandemic, government support was provided to allow workers to stay at home to control the spread of the virus. Families continued their normal spending habits despite low inventories from damaged supply chains with this support. As a result, prices rose to reflect this high consumer demand and low product supply creating the inflation we see today.
- Higher Interest Rates
Source: https://www.federalreserve.gov/m 1
The Federal Reserve has begun discussing increasing interest rates to fight these inflationary pressures. Higher interest rates cool inflationary pressures by slowing demand in the economy. Specifically, as interest rates rise, larger financed purchases like buying a home or a car become more expensive. You can see this relationship in the chart below of mortgage rates and home purchases. As the 30-year mortgage rate increased from the January 2021 low of 2.65% to 3.89%, new home sales decreased by 30%. Higher rates are the Fed’s primary tool to break the back of inflation, but it will likely slow economic activity.
- Less Fiscal Support
During the onset of the pandemic, the US Government provided support through multiple programs; however, these programs are being retired, and fiscal support is ending. According to the Congressional Budget Office, 2022 will result in a decline in Federal Outlays of $146 Billion. With decreases coming in unemployment compensation, refundable tax credits, and spectrum auction receipts.
Source: https://www.cbo.gov/system/files 1
- Slowing Economic Growth
The combination of higher inflation, higher interest rates, and less fiscal support is depressing consumer confidence. In the most recent Survey of Consumer Confidence by the University of Michigan, Economist Richard Curtin stated that sentiment remains at its lowest level in the past decade (Curtin, 2022). Curtin says that the loss of confidence was entirely due to a 12.9% decline among households with incomes of $100,000 or more. This decline in confidence primarily comes from a decrease in incomes due to rising inflationary pressures. With the economy still driven by consumer spending, a drop in income will decrease consumption, resulting in lower economic growth in 2022. Below is the current estimate of Q1 GDP from the Federal Reserve Bank of Atlanta, citing a 0.6% growth rate.
- Russia/Ukraine Tensions
Higher inflation, higher interest rates, less fiscal support, and slowing economic growth had already taken place before Russia decided to invade Ukraine. However, now that Russia has stepped across the border, markets accelerated their sell-off. I see two potential reactions to this invasion.
One potential reaction is the upward pressure on oil prices. With Russia as a large oil producer, a shock to their economy could create a shock to the global oil market resulting in increased oil prices and greater inflationary pressures. Second, I see the US and NATO allies’ response as another potential reaction. Increased sanctions could create greater supply chain and financial risks, given Russian banks are blocked from SWIFT banking systems. These financial and economic risks can spread to other countries with direct ties with Russia causing risk to spread across other areas.
What does this mean for investors?
We believe these five risks will take most of 2022 to abate, creating a less favorable outlook for financial markets. Given the uncertainty around these risks, we think it’s prudent to remain cautious in 2022.
|SYMBOLS||WEEK RETURN||YTD RETURN|
|SECTORS||WEEK RETURN||YTD RETURN|
|Cons Discretionary (XLY)||0.72%||-16.82%|
|Cons Staples (XLP)||0.55%||-1.67%|
|Real Estate (XLRE)||2.86%||-10.97%|
|Health Care (XLV)||2.90%||-6.27%|
|Data Provided by Yahoo Finance||As of 2/25/2022|
Sectors are shown using Unique Exchange Traded Funds (ETFs) that divide the S&P into eleven index funds traded throughout the day on NYSE Arca. To learn more: https://www.sectorspdr.com/sectorspdr/features/about
Sector SPDRs are subject to risk similar to those of stocks including those regarding short selling and margin account maintenance. All ETFs are subject to risk, including possible loss of principal. Sector ETF products are also subject to sector risk and non-diversified risk, which will result in greater price fluctuations than the overall market.
This material is provided as a courtesy and for educational purposes only. Please consult your investment professional, legal or tax advisor for specific information pertaining to your situation. All information contained herein is derived from sources deemed to be reliable but cannot be guaranteed. All economic and performance data is historical and not indicative of future results. All views/opinions expressed in this newsletter are solely those of the author and do not reflect the views/opinions held by Advisory Services Network, LLC. The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. Indexes are unmanaged and do not incur management fees, costs, or expenses. It is not possible to invest directly in an index. The Dow Jones Industrial Average (DJIA) is a price-weighted index of 30 actively traded blue chip stocks. Indexes are unmanaged and do not incur management fees, costs or expenses. It is not possible to invest directly in an index.
Curtain, R. University of Michigan Consumer Confidence Survey Feb. 2022. Retrieved from: Surveys of Consumers (umich.edu)