February 17, 2022 Letter to Clients
With this being the first letter of 2022, I wish you a happy new year and that this letter finds you and your family in good spirits and health. Hopefully we are all returning to activities once enjoyed before the pandemic. In my own household, having my children return to in-person learning and sports has been very welcomed.
I recognize that our clients are accustomed to receiving our first quarterly letter of the year in January, however we chose to wait just a bit as the beginning of 2022 proved to be particularly full of announcements, news and global events impacting the markets and economy, a few of which we will address in this letter. The first several weeks of 2022 have also undoubtedly reminded many of us that when the markets are experiencing a pullback, even when in the form of a healthy and perhaps arguably overdue market correction, it can feel uneasy being an investor, challenging many of us to remain steadfast in our financial plans.
Reflections on Corrections: A Look Ahead Into 2022
Heading into this year, we expect growth will ease and returns will be more moderate as the rip-roaring rallies brought about by the reopening and stimulus have come to an end. Risks will be also prevalent, but so will opportunities. The first weeks of this year have already confirmed that 2022 will not offer a “straight line” to say the least. Steady, consistent gains followed the coronavirus March 2020 stock market crash, fueled in part by the outpouring of money from the Federal Reserve (the Fed), a near-zero interest rate environment coupled with bond buying, had the financial markets climbing an almost straight line upward since that historical crash. This can understandably make the current bumpy ride feel disconcerting. Historically, these market corrections, defined as a 10 percent drop from the most recent high, are viewed as a normal and healthy occurrence. The market is pausing, taking a breath, and reevaluating equity valuations. A market correction can put an end to a huge run up that is unsustainable and presents some attractive buying opportunities, which in turn then promotes more sustained growth going forward. In poker terms, these corrections flush out the weak hands, as those who have been riding the momentum will fold by selling followed by seasoned investors who seize the opportunity to buy at lower prices. The current volatility is still well within normal ranges, as the S&P 500 averages three pullbacks of 5 percent or more, along with one correction each year. However, as it has been two years without a correction and the S&P 500 having more than doubled since March 2020, this one may feel especially jarring.
One primary cause of the market’s volatile start to the new year lies with Federal Reserve Chairman Jerome Powell’s announcement that the Fed is shifting away from accommodative policy with an end to the extraordinary support given to the economy during the pandemic. This will come in the form of what will most likely be a series of rate hikes, beginning as early as next month in an attempt to rein in record high inflation, not felt since the 1980s.
Inflation and Consumer Spending
Inflation remains a pressing topic into the start of the 2022 and I anticipate will be a continuing topic of conversation in our letters going forward for some time. Across several countries, inflation has hit its highest level in decades and here in the U.S., it remained prominent as the current annual inflation rate by the end of last month was at a 40 year high of 7.48%.
Inflation itself isn’t always bad news. A little inflation can actually be healthy for the economy. The Federal Reserve is tasked with the job of keeping inflation at targets in the approximate 2 percent range over time. This can prove troublesome to control in the most normal of economic conditions, never mind in a world dealing with a pandemic-induced economic shutdown and reopening. The Fed uses interest rates as either the gas pedal or the brakes on the economy as needed to direct the inflation rate up or down. Currently, with the inflation rate running very hot, a series of interest rate hikes are expected to occur this year in an effort to pump the brakes. But, just how aggressive the Fed will be remains to be seen as they balance their plan to curb inflation without overly stunting the economic growth outlook ahead.
There are two basic reasons why inflation is running hot: supply and demand. Consumer spending fell around the same time as coronavirus cases kept busy Americans at home. With the return to shopping, dining, and traveling outside the home, coupled with households’ buying power boosted by the pandemic-related aid, this higher demand has led to higher prices. And while higher demand isn’t typically a bad thing, throw in a significant global supply chain problem coupled with higher production costs and higher employee wages and the result is prices on essential goods fast becoming unaffordable for many, especially for those who have not seen an increase to their paychecks. Also, caught off guard by the bounce-back, companies have scrambled to find supplies and workers to meet an unexpected surge in orders.
One area you may be feeling this pinch to your wallet in is when venturing into your local grocery store and your spending limits have exceeded their normal amounts. The supply shortages and massive financial stimulus discussed have contributed to increasing consumer prices. Prices of meat, seafood, produce, dairy, and other products have shot up by 9% in 2021. Grocery shortages are especially concerning as various items have gone in and out of stock. As we discussed in our last letter, the cargo ship congestion off the California coast was creating supply chain bottlenecks and had hit a record high in January, with 109 ships waiting to unload. Fortunately, port officials have reported that the backup is now shrinking, although they remain cautiously optimistic given that the Chinese Lunar New Year historically creates a lull in inbound shipments. With less employees missing work due to Covid-19 and more workers returning to or accepting new shipping-related jobs, the bottleneck for the moment appears to be becoming more manageable.
The current projections show that if inflation expectations stay well anchored, inflation will gradually decrease to levels closer to 2.6% by the end of 2022 as supply-demand imbalances subside and financial policy in major economies respond. While notably much lower than current levels, we may not see levels drop to that targeted 2% range until 2023 or 2024.
Russia – Ukraine Conflict
The potential conflict in Eastern Europe and what the global response will be, has also been fueling volatility in the markets. This tension between Russia and Ukraine has escalated at the same time the markets are already grappling with inflation concerns and the announcement of Federal Reserve tightening. Additionally, all eyes will be on the building pressure between China and Taiwan, with China’s President Xi Jinping indicating his country would not rule out a possible use of force in his country’s quest to make Taiwan, which considers itself to be an independent country following World War Two, part of China once again.
History has shown that conflicts, such as what is occurring between Russia and Ukraine, while a potential devastating humanitarian crisis, often have a fleeting impact to the U.S. stock market. Markets do have the ability, for the most part, to quickly dismiss these geopolitical events…. except when oil and natural gas is involved. Russia is the world’s third-largest oil producer, contributing more than 10% to global production. With the global oil market already fragile as demand has outpaced production with the easing of pandemic restrictions and economic rebounds, the threat of Russia invading Ukraine leaves the precarious balance of supply and demand in question. This month alone, the price of oil has jumped to seven-year highs and that price will continue to surge should an invasion occur, leaving drivers paying more at the pump and homeowners coping with rising heating costs and businesses incurring higher shipping costs. Adding to that, Europe is heavily reliant on Russia for its natural gas supply and if the current tensions turn into a full-blown conflict, that dependence will be sorely felt if sanctions are imposed resulting in the shut-down of pipelines.
Less prominent in the headlines than oil, but equally deserving of attention, is the disruption that will be experienced by wheat and grain exports, being that Ukraine, Russia, Kazakhstan and Romania all ship from ports in the Black Sea. With Russia and Ukraine being major exporters of wheat and corn, conflicts occurring in the Black Sea region will most certainly impact those prices worldwide, furthering food inflation.
This conflict about the future of Ukraine and Russian President Vladimir Putin’s attempt to reassert influence in Europe and the world has the potential to bring on a humanitarian crisis if it further escalates into a war. While that is of course at the forefront of our minds, as your financial advisor it is my role to be mindful of the impact to the stock market and economy. I fully recognize the discomfort and even angst that can be felt by our clients when their investments are experiencing the volatility occurring in the markets. I’m no stranger to it myself as an investor. I am reminded, however, that history tells us that stocks largely shrug off geopolitical unrest in other parts of the world and that unrest has little sustained impact on stock markets or economic growth here in the United States.
The truth is, as devastating as these events are, the stock market can withstand such conflicts and properly positioned portfolios can capitalize on them. For our clients, we are always striving to do our very best, and although we do anticipate market volatility to continue as events unfold, it is our hope that you take reassurance that you are working with an experienced team that is well seasoned, in all market conditions. We draw on this experience and expertise to position our clients’ portfolios in an intelligent manner. As always, we are available to address any concerns you may have and to discuss the approach we are taking related to your investments.
History has shown that conflicts, such as what is occurring between Russia and Ukraine, while a potential devastating humanitarian crisis, often have a fleeting impact to the U.S. stock market. Markets do have the ability, for the most part, to quickly dismiss these geopolitical events…. except when oil and natural gas is involved. Russia is the world’s third-largest oil producer, contributing more than 10% to global production. With the global oil market already fragile as demand has outpaced production with the easing of pandemic restrictions and economic rebounds, the threat of Russia invading Ukraine leaves the precarious balance of supply and demand in question. This month alone, the price of oil has jumped to seven-year highs and that price will continue to surge should an invasion occur, leaving drivers paying more at the pump and homeowners coping with rising heating costs and businesses incurring higher shipping costs. Adding to that, Europe is heavily reliant on Russia for its natural gas supply and if the current tensions turn into a full-blown conflict, that dependence will be sorely felt if sanctions are imposed resulting in the shut-down of pipelines.
Less prominent in the headlines than oil, but equally deserving of attention, is the disruption that will be experienced by wheat and grain exports, being that Ukraine, Russia, Kazakhstan and Romania all ship from ports in the Black Sea. With Russia and Ukraine being major exporters of wheat and corn, conflicts occurring in the Black Sea region will most certainly impact those prices worldwide, furthering food inflation.
This conflict about the future of Ukraine and Russian President Vladimir Putin’s attempt to reassert influence in Europe and the world has the potential to bring on a humanitarian crisis if it further escalates into a war. While that is of course at the forefront of our minds, as your financial advisor it is my role to be mindful of the impact to the stock market and economy. I fully recognize the discomfort and even angst that can be felt by our clients when their investments are experiencing the volatility occurring in the markets. I’m no stranger to it myself as an investor. I am reminded, however, that history tells us that stocks largely shrug off geopolitical unrest in other parts of the world and that unrest has little sustained impact on stock markets or economic growth here in the United States.
The truth is, as devastating as these events are, the stock market can withstand such conflicts and properly positioned portfolios can capitalize on them. For our clients, we are always striving to do our very best, and although we do anticipate market volatility to continue as events unfold, it is our hope that you take reassurance that you are working with an experienced team that is well seasoned, in all market conditions. We draw on this experience and expertise to position our clients’ portfolios in an intelligent manner. As always, we are available to address any concerns you may have and to discuss the approach we are taking related to your investments.
Optimism and Moving Forward
During periods when the stock market is experiencing significant daily swings and there is uncertainty as we wait for events out of our control to unfold, it is human nature to question the financial plan put into place. In my role as your financial advisor, I am available to provide you with guidance and reassurance to ensure you feel confident that your investment wellbeing remains on track; whether you are one of our young investors with a long-term time horizon ahead of you or if you are nearing or in your retirement years. For both, staying the course through what is viewed as short-term volatility is shown to be the best course. Active monitoring of investment portfolios, such as what we do, is especially critical as the tides change in the financial markets.
While the effects of the pandemic continue to be ever present and the headlines focus on inflation, supply chain challenges, and the labor market, as well as international tensions, there are reasons to be optimistic. The most important being that new Covid-19 cases and hospitalizations have decreased significantly. This is not only welcome news from a health standpoint, but from a recovery one as well, which is dependent on the course Covid-19 takes. The economic rebound in the United States has been fast-recovering and there is a strong demand for labor with the unemployment rate over the past year having decreased, now inching closer to pre-pandemic levels.
As events, both globally and here at home, unfold, we anticipate sending another letter soon to discuss our commentary of the markets, economy, and impact to the financial markets. However, as always, I invite you to contact our office if you wish to consult with me and I will gladly listen to your thoughts and questions.
In other good news, we are pleased to welcome our newest member to our firm, Kristen McNamara. Kristen, a Belchertown native, joined our firm in January and has quickly become acclimated to her role as a client relationship manager. She looks forward to providing the superior service our clients are accustomed to and getting to know each of you personally.
Sincerely,
Steve LePage