I penned my first quarterly commentary in April of 2020. At that time, the topic was obvious. COVID-19 exploded onto the scene, and the world was essentially shut down. We faced an uncertain future. Exactly two years later, it appears just as obvious what to write about — the war in Europe and inflation at a level unseen since the early 80s. The human tragedy in Ukraine is horrific. With that said, much of the discussion of this paper will focus on the war’s economic impact.
When Russia invaded Ukraine on February 24th, I was somewhat shocked. I say somewhat, because it appeared for a while this was the direction in which the conflict was headed. I say shocked, because I never imagined in my lifetime I would see tanks and ground troops fighting on European soil. This seemed like something that would have happened 75 years ago. As we already know, a war in this part of the world has vast implications. Russia acted as an unprovoked aggressor, so they have been all but shut off from the world economy. Their stock market was closed for over a month, many companies have stopped selling their products in Russia, and many countries have banned the purchase of Russian oil and gas.
The ramifications of the war will be felt well into the future, even if the conflict were to end tomorrow (unfortunately, there is little indication this will be the case). This part of Eastern Europe is known as the world’s breadbasket, with nearly a third of the world’s wheat and barley exports. Losing spring planting season will have tremendous effects around the globe, especially for people in Europe, Asia, and Africa. The degree of disruption to the world’s food supply will depend on how long the war lasts. Unfortunately, food shortages will be most significant in the poorer countries of Africa, which buy most of their wheat from Russia.
The war in Europe has played a significant role in spiking energy and food prices, but the war alone has not caused the record inflation we are seeing. Government spending to combat the pandemic, supply chain disruptions due to the pandemic, and years of historically low-interest rates have sent inflation to levels last seen 40 years ago. The latest CPI (Consumer Price Index) showed inflation of 8.5%, but it is higher for many goods and services. Have you looked at the price of a used car or the cost of filling a gas tank? The Federal Reserve has begun raising interest rates to get inflation under control. The consensus is that the Fed will raise rates another six times (or 1.5%), or more, during the rest of 2022. As rates rise, consumers and companies pull back on spending, hopefully, cooling off inflation. The Fed aims for a “soft landing,” a slowdown of economic growth without pushing the country into a recession. Although they might not admit it, the other reason the Fed feels the need to raise rates is that they must have room to lower the rates the next time the economy slows down.
With a war, inflation, supply chain troubles, and a virus that has not gone away, it is understandable that stocks have pulled back to start 2022. The S&P 500 finished the quarter down 4.62% but was down almost 10% at one time. To keep this in perspective, it is still up almost 90% since the pandemic lows of March 2020. International stocks have faced even more difficulty, pulling back almost 6% after being down almost 15% as measured by the MSCI EAFE Index1.
Usually, fixed income can be counted on to provide positive returns as investors flee the volatility of stocks during a pullback. This has not been the case so far in 2022. The Barclays Agg2 fell almost 6% during the quarter as interest rates rose. When investors believe rates will rise, current fixed income holdings are sold, and the value of bonds decrease. Why would an investor want a bond paying 3% interest when a new bond with the same risk characteristics pays 4%? While no one likes to see capital depreciation, over time, this will lead to higher interest payment on fixed income, which is a positive.
With everything discussed, what is an investor to do? As simplistic as it may be, the best advice is to stay calm and follow your long-term plan. Pulling everything from the markets and stuffing your mattress only assures a loss of purchasing power equal to the inflation rate (and likely a pretty good tax bill after the gains of the last two years). As if all that has been discussed is not enough for the markets to digest, the fact that it is an election year should only add to the excitement and likely volatility. While volatile markets could lead to concern for some, volatility can lead to opportunity when you have a plan in place.
As I attempt to find a perfect way to finish this, I realize this is a doom and gloom commentary. I want to point out there is a lot to be optimistic about as we head into the heart of spring and summer. We have record low unemployment of 3.6%, and so far, first quarter results are good, with 79% of S&P companies beating expected earnings per share. COVID, while around, is not controlling our lives, and it seems everyone I speak with has great family trips planned. Last, but not least, the Dawgs and the Braves are still champions (last time, I promise).
1MSCI EAFE Index is an equity index which captures large and mid cap representation across 21 Developed Markets countries around the world, excluding the US and Canada.
2Bloomberg Aggregate Bond Index broadly tracks the performance of the U.S. investment-grade bond market. The index includes government Treasury securities, corporate bonds, mortgage-backed securities (MBS), asset-backed securities (ABS), and munis to simulate the universe of bonds in the market. It tracks bonds that are of investment-grade quality or better.
The views and opinions expressed are of Persium Advisors, LLC. This commentary is provided for educational purposes only and should not be construed as investment advice. Persium Advisors is an investment advisor firm located in Atlanta, GA.
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