As you most likely noticed, the market has experienced increased volatility since the beginning of the year. As we discussed in our Econ Outlook Webinar in January, this was not unexpected.
There are several factors contributing to the increased volatility - and the Russian invasion of Ukraine is now another unfortunate factor.
With it all, the market is digesting quite a bit of information.
First, the Federal Reserve is in transition. Monetary policymakers are moving from accommodation to normalization. Their plan is to end their bond purchases in March (removing liquidity), while increasing their benchmark interest rate throughout the year.
The goal is to prevent an overheating of the economy and to tame inflation. Rising rates increase the cost of borrowing for consumers and corporations. Higher interest rates also increase the risk-free rate investors use to discount the price and cash flows of stocks.
We are going through this discounting process now. You’ve probably seen the wide variance in speculation just over the last two months on just how aggressively the Fed will be in raising rates.
When the year started, the consensus was that we’d see four rate hikes of .25% over the calendar year. The inflation rate continued to climb. As of yesterday, markets were pricing in a “slightly better than 50% probability that the Fed will enact seven hikes this year, which would translate into a raise at each of its remaining meetings, according to CME Group data.”1
With the conflict in Ukraine expanding, expectations around how aggressively the Fed could raise may moderate.
Second, we’re likely to experience a transition from pandemic induced spending on goods to post-pandemic spending on services. Consumers are shifting their dollars from the purchase of things to the purchase of experiences such as airlines, hotels, and restaurants. It can be difficult to value companies until the data confirms or disproves this transition throughout the year.
Third, we are coming off three strong years for US equities.
2021 was a year of uncharacteristically low stock market volatility. It makes sense for markets to take a breather here and reassess.
Looking at the Russia/Ukraine conflict, it helps keep some perspective. There is no minimizing the horrible effects of military conflict. However, when you look at it from an investment perspective, we see that past conflicts have brought an initial market impact, but that volatility has typically been short lived. Markets soon go back to assessing the fundamentals of the economy and the prospects of individual companies. Stock market returns are much more closely linked to those items than geopolitical events.
US markets closed yesterday with a significant rally in stocks and there was broad buying today. Nevertheless, I don’t expect we’ve seen the last of this considerable market chop. There’s no way to know how or if this conflict escalates.
As you know, we are an extremely fact-based and data dependent firm. We will continue to make portfolio adjustments that reflect the current economic and market environment.
In light of recent market movement and challenging headlines, it’s always a good idea to take a step back and look at the big picture. For that reason, I’ll leave you with the 10-Year total returns of both the S&P 500 and a sample globally balanced diversified portfolio of stocks and bonds.
Please reach out if you’d like to discuss further.