By: Linda S. Parenti, CFA - Chief Investment Strategist
Earlier this week, two measures on inflation were released. The Consumer Price Index (CPI) rose 8.5% versus last March, which is the highest reading since December 1981. The jump in March’s Producer Price Index (PPI) was even hotter, showing prices paid by wholesalers for goods and services up 11.5% from a year ago. High inflation is one of the main reasons that consumer and investor sentiment is currently quite negative.
Considering the reports, both the bond and stock markets seemed to digest those historically significant levels relatively well this week. Year-to-date on a total return basis, the S&P 500 equity index is still down 7.5% and the Bloomberg U.S. Aggregate Bond Market Index is down 8.5%. But it may be that both markets have somewhat priced in expectations for elevated inflation data and become accustomed to the increasingly hawkish comments from Federal Reserve officials. When negative headlines repeatedly fill the airwaves, bad news becomes expected. With inflationary pressures, rising interest rates, and the ongoing war in Ukraine as main concerns currently capturing investor attention, more promising trends can be overlooked or easily dismissed.
Although the Fed is talking tough and may very well throw in several aggressive rate increases in the months ahead, what they wind up doing by year end could turn out to be less than expected. First, the markets always do some of the work for them. Additionally, there are signs that supply chains may be starting to improve and suggestions that inflation could be close to peaking. Reliable gauges of economic strength such as the Leading Economic Indicators (LEI) are healthy and rising. Employment is strong and bigger paychecks are helping consumers continue spending even with higher prices. Corporate earnings this year are still expected to show modest gains beyond last year’s impressive results, and U.S. economic growth (GDP) is forecast to rise 3% in 2022. All these factors lend important support for stock prices notwithstanding the negative headlines.
As I mentioned in a previous Market Insights, rising interest rates do not necessarily spell doom for the economy or equities. Especially considering they are coming off such low levels and are doing so during a period of economic strength. If you compare periods when the Fed was lowering versus raising rates, stocks typically perform better during the latter. This makes sense if you think about how monetary policy works. The Fed eases (lowers interest rates) when the economy is weak or in a recession. They tighten (raise interest rates) when the economy is strong to lower inflation.
I’ll end with a note on bull and bear market cycles. Although we do not foresee a bear market on the horizon, they inevitably occur and should be expected when investing in equities. In fact, corrections and bear markets serve as important resets in pricing. Of course, in uncertain times when we hear compelling reasons for a recession ahead and markets are volatile, what might seem logical is to reduce one’s stock exposure. However, markets often do not respond as expected. For example, the news from Ukraine is overwhelmingly disheartening and the war in that region has added further stress to energy and agricultural commodity supply chains. Yet, the S&P 500’s price is 2.4% higher since the February 24th Russian invasion.
At times such as these, it is important to remember that market timing rarely works because it requires two correct decisions. Not only when to get out, but also when to get back in. Given your allocation to fixed income and cash is sufficient to meet your cash flow needs for approximately three to five years, a much more reliable approach is to hold and manage equities through market downturns. Rather than trying to predict the next cycle turn, we use those periods as tax strategy opportunities for our individual investors to harvest losses while repositioning holdings or to capture more reasonable gains and reinvest in a favored holding to improve the cost basis. It takes patience and fortitude to be a long-term investor, but history has shown that time is on your side.
Linda S. Parenti, CFA
Chief Investment Strategist
RISKS AND IMPORTANT CONSIDERATIONS
Views and opinions expressed here are for informational and educational purposes only and may change at any time based on market or other conditions or may not come to pass. This material is not a solicitation to buy or sell securities and should not be considered specific legal, investment, or tax advice. The information provided does not consider the objectives, financial situation, or needs of any specific individual. All investments carry a degree of risk and there is no certainty that an investment will provide positive performance over any stated period. Equity investments are subject to company specific and market risks. Equities may decline in response to adverse company news, industry developments, or economic data. Fixed income securities are subject to market, credit, and interest rate risks. As interest rates rise, bond prices may fall. Past performance is no guarantee of future results.