First Quarter 2022
As we head into spring, much of what we wrote about in our 2021 year-end letter continues to hold true. While it appears the worst of the Omicron variant is behind us, supply chains remain kinked and staffing shortages persist. Demand has exceeded supply for many products, resulting in inflation numbers we have not seen in decades. The recent fighting in Ukraine has further added to price increases across many commodities, especially the price of gasoline at the pump. Demand for housing continues to be elevated and is pricing many potential homeowners out of the market. As we expected, the result has been higher interest rates and a more volatile stock market, as the economy transitions away from government supported quantitative easing to one that is left to stand on its own. In the long run, this is the more favorable outcome.
The situation in Ukraine continues to dominate the airwaves. If the fighting can be contained, history would tell us that the stock market should improve following the sell-off at the beginning of the war. However, a major concern with this conflict is that the fighting expands further into Europe, potentially dragging the US deeper into the war. It is extremely difficult to guess what will happen and is something we will monitor closely.
As investors, we need to balance the positive effects of a stronger economy with the potential drag of higher interest rates
and sustained inflation. This will be a delicate balancing act.
Inflation continues to run at the highest levels since the early 1980’s. In response, the Federal Reserve hiked the federal funds rate 25 basis points in March. The Fed also communicated its plan to hike this rate another 6 or 7 times in 2022, with more possible in 2023. We have felt that the Fed has been holding rates low for too long, so we welcome this change in policy. However, increased rates will have an impact on the stock and bond market. Looking at the past 12 rate hike cycles, the stock market had a positive return in 11 of those instances, so blindly selling is not the best course of action in our opinion. We will continue to be diligent in analyzing stocks for attractive entry and exit points amidst the price volatility that will likely ensue.
The good news is that the economy seems to be improving as we exit the worst of the pandemic. After two years of lock downs, businesses are reopening and demand appears strong. As investors, we need to balance the positive effects of a stronger economy with the potential drag of higher interest rates and sustained inflation. This will be a delicate balancing act.
Cash continues to be an important part of our investment strategy. The stocks of many quality companies corrected during the first quarter, making valuations more attractive. We will selectively look to reallocate assets between stocks where appropriate. As rates rise, we will look to add to our bond positions to generate more income in balanced accounts. This may occur over weeks or even months depending on the speed and the size of any increase in interest rates.
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This article can provide only a general understanding of sometimes difficult financial concepts. For for a more thorough explanation, or if you have questions about your own portfolio, please feel free to reach out to us here at McRae at (973) 387-1080.