Vigilare Wealth Management 2022 Q1 Commentary
The host of risk factors we highlighted in our prior commentary came to fruition in the first quarter. Atrocities in Eastern Europe added to an already uncertain global economic environment. This caused market volatility that affected all asset classes, even those more traditionally conservative ones such as bonds. The normally sleepy bond market was down 6% in the first quarter alone.
In our October commentary we mentioned the Fed starting to “wake up” to inflation concerns and the potential for a strong pivot to address this emerging risk. Since then, inflation has morphed into a more ubiquitous economic reality, and the Fed for the first time since the 70s/80s is more focused on fighting inflation over supporting growth. Economists are now predicting multiple rate hikes over this year to get inflation under control, including at least a half-percent hike at the May meeting. This would be the first half-percent rate hike since May of 2000. Fed tightening cycles are always a balancing act to ensure that rate hikes quell inflation but do not trigger a recession. In prior instances the outcomes have been mixed. There have been several examples of rate hikes leading to recession, but also some to soft landings (1994 for example).
Our preliminary view is that inflation may self-moderate over the next few quarters. This means we think there is also the risk that the Fed moves too aggressively (like that has never happened before??) and the economy slows more than expected. Here are some of the reasons we believe inflation may moderate. There will be a muted fiscal response now as opposed to the “bazooka” Covid response actions of 2020 and 2021. For example, individual stimulus checks, enhanced unemployment benefits, state and local relief, child tax credits, and forgivable business loans are all lower or already expired. Supply chains backlogs should also start to moderate and incessant demand for pandemic items (used cars, exercise equipment, office furniture, etc.) may decline more than expected. Also, market expectations have already priced in several rate hikes and mortgage rates for example have already moved to multi-year highs. In addition, food and energy which are now scorching hot, are also the most volatile inflation components and can easily move lower through higher prices bringing down demand and/or new sources of supply coming online to capitalize from higher prices. Any positive developments from the invasion of Ukraine would also ameliorate some of these pressures. Finally, the dollar has remained relatively strong which would likely not continue if inflation expectations became convincingly unanchored.
We do expect volatility to persist into the next quarter given these pressures. Risks are highly elevated because of the recent geopolitical escalations and the Fed’s newfound approach to shoot inflation first and ask questions later. There are several “indicators” flashing yellow/red that usually flare up around slowdowns/recessions. Employment indicators will be especially important to watch. This does not mean a recession is a given however, but more caution is warranted.
It is not all doom and gloom. Markets are forward looking. Today some market sentiment indicators are the most negative they have been in over thirty years (yes even more than the global financial crisis, the dot com meltdown and 911!). Surprisingly, these extreme negative sentiment readings are almost always observed during market bottoms. We had mentioned in our last commentary that negative surprises would have more of a negative impact on the markets than usual. Given that sentiment is so negative now the opposite is true today (positive surprises will have a greater than average positive impact on the markets). This means that “less-worse” news can be construed as a positive for the markets.
Today’s backdrop is very unusual because there are such large number of “unresolved unknowns”. This makes for a wide range of potential outcomes (both good and bad or both). Traditionally, “risk” can be quantifiable, but “uncertainty” is more challenging in that regard. For this reason we are going to remain open to a wide range of outcomes (with an emphasis on caution) until there is more definitive data and direction.
The Vigilare Wealth Management Team
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