Vigilare Wealth Management 2022 Q2 Commentary
on July 7, 2022
Stocks had their worst start to a year dating back to 1970 and the bond market suffered its worst decline dating back to before 1900. In fact, the only asset that held value in the first half of the year was the U.S. dollar. Oil had also risen considerably given the geopolitical risk factors but is now down considerably from its peak. In our prior commentary we outlined our strategy for a more cautious approach. We highlighted our concerns of elevated risks which included the Russian invasion of Ukraine and the U.S. Federal Reserve’s focus on stomping out generationally high inflation. Unfortunately, these risks continue to loom over the markets going into the second half of the year.
We had also mentioned that several early recession indicators we track had started to flash yellow. These indicators are more apparent now and it is likely the U.S. will be in a recession, if not already in one. For some context, the median drop for the stock market in a recession is around 25% looking back at post World War II data. The markets have already suffered a decline of that magnitude this year. The key question then becomes the scope and severity of a looming recession.
Looking at post World War II data, the markets have had declines of 15% or more 17 times, and in 11 of those 17 occurrences the market found a bottom when the Federal Reserve shifted from a tightening policy response to a more accommodative policy (I.E., they stopped raising rates). Currently, the Fed is still laser focused on raising rates to combat inflation. So far this year the Fed has raised rates three times, moving the fed funds rate up to 1.75%. They are projected to continue raising rates, including another .75% in July, and several more over the next meetings, to end the year at a 3.5%. Our view is that a year-end target of 3.5% is overly ambitious and the economy will struggle mightily with such aggressive policy actions.
We will be monitoring incoming economic data to ascertain the emergence and magnitude of any slowdown and the evolving response of the Federal Reserve. Any pivot away from a tightening cycle would be a big positive for asset prices. Market expectations and Fed projections are for ongoing rate hikes; however, we anticipate the Fed to surrender sooner than most think. These dynamics will have major implications for the economy and financial markets.
Inflation almost always moderates in a recession (at least looking back at past recession data over last century). If the Fed manages a “soft landing” slowdown, then the markets could already be close to finding a bottom. However, if inflation is more persistent and/or the slowdown is more severe, then there could be much more downside to the economy and to the financial markets. We view the escalation of the following risk factors responsible for tipping the likelihood of a nastier recession: Continuation of Russian invasion, China aggression in Asia, Federal Reserve over-raising rates, a surprise systemic shock to the financial system (E.G. Lehman brothers).
We continue to be conservative and guarded until these risk factors abate and/or stock market prices more adequately reflect these risks. In this environment conditions can change at a moment’s notice, so we will be taking appropriate actions as well as keeping everyone posted.
Thank you for your trust.
The Vigilare Wealth Management Team
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