Q–1 2022 MARKET REVIEW
Financial markets were whipsawed by news on inflation, Federal Reserve interest rate increases, the Russia invasion of Ukraine, and China’s determination to enforce a zero COVID policy regardless of its domestic and global economic implications.
Inflation has been on a tear since mid 2021. Initially discounted as a transient side effect of business reopening and reawakened consumer demand in countries seeking to live with the COVID virus, there is now a widely ascribed to opinion that inflation has the real possibility of becoming entrenched beyond this supply chain disruption, that it will drive a wage/price upward spiral and end in an economic recession. The Federal Reserve Bank’s battle with run-a-way inflation in the early 1980’s and the subsequent is on many market analyst minds.
The war in Ukraine kicked off by the Russian invasion in early February 2022 further stressed product availability versus consumer demand. The blow back from Western imposed economic sanctions on Russia is apparent in the price of gasoline, agricultural commodities and fertilizer.
In February 2022, inflation in the United States was pegged at 7.9% the highest reading since January 1982.
Market analysts parsing statements by Federal Reserve Bank members now anticipate as many as seven 0.25% increases in 2022 and four in 2023. Assume a 2% annual rate of inflation. Once that is imputed into the projected Federal Reserve’s anticipated rate increases drive rate increases, the consumer may well see effective short term interest rates approximating 5% by the end of this rate hiking cycle.
In its effort to combat inflation and tighten monetary policy the Federal Reserve is also expected to reduce its balance sheet. Owned US Treasuries and mortgage-backed securities will mature without further reinvestment.
Projections are not necessarily indicative of what will actually occur. The Federal Reserve Banks signal of more tight monetary policy will steepen the interest rate curve on the short end. Longer term interest rates have not changed commensurately suggesting that there is less expectation that there will be run-away inflation. This flattening or possible inversion of the yield curve, however, might signal market expectation of an impending recession.
The deteriorating geopolitical and economic reality pushed the ten-year bond rate up from 1.5% at the beginning of the year to a peak of 2.4% during the quarter.
The slowing global economy may restrain the Federal Reserve Bank from implementing the anticipated number of rate increases. There is a concern that the tightening of monetary policy has begun too late. The current more aggressive policy adds to concerns of a possible recession in 2023.
The United States is not alone in confronting heightened inflation. Interest rate hikes have been implemented in several countries including Great Britain, the European Union, Brazil, Taiwan, Korea and Hong Kong.
What success increased interest rates will have in taming inflation remains to be seen. James Stock and Mark Watson, at Harvard and Princeton Universities respectively, suggests that less than half of the relevant indicators of inflation are reflected in the index the Federal Reserve Bank uses to gauge inflation at play in the economy. As such, policy decisions may be premised on a less than representative basket of indices and effort to curtain consumer demand through higher borrowing cost may not appropriately address the inflation dynamics at play in the economy.
Countries aligned with the European and American world view responded to Russia’s invasion of Ukraine with sanctions on most Russian commodity exports. Europe has exempted energy related commodities from the sanction regime. Much of the Euro block is heavily dependent on Russian energy commodities to meet household and industrial production demand. Dislocation in the harvesting and shipping of Ukraine and Russian grains will have a profound impact on developing countries, which depend on these imports to feed populations and livestock. Reduced exports from these two countries that are major suppliers of chemical fertilizer will adversely impact agriculture.
The Russian sanction regime has shuttered many foreign business operations in Russia. These companies must now write down or off the value of those Russian assets. Russia has threatened to nationalize shuttered non-Russian businesses. Aircraft leasing companies in particular have incurred significant losses. Leased aircraft parked on Russian runways are beyond the reach of foreign companies’ ability to physically repossess these assets.
China remains steadfast in its commitment to a zero COVID policy. The mainland government pressured the Hong Kong administration to impose lock downs despite the impact on the island’s financial sector. By quarter end, tens of millions of residents in several large cities including Shenzhen and Shanghai are in government-imposed lockdown. China remains the world’s manufacturing center. Supply lines are further disrupted as factories shutter. The knock-on effect is to further exacerbate efforts to rein in inflation in countries heavily dependent on Chinese manufacturing imports.
This slowdown in Chinese manufacturing has reduced demand for global fossil fuels. It has ameliorated the upward pressure on oil prices. Brent oil peaked in early March 2022 at $130/barrel in large part a function of Russian sanctions. Russia remains the world’s third largest source of crude oil and the world’s largest exporter of oil and petroleum products. By quarter end, Brent oil prices were at $103/barrel.
Slowing Chinese economic growth appears to have stymied implementation of its “common prosperity” initiative. In 2021, this policy and its associated increase in regulatory oversight of economic activity adversely impacted Chinese companies in particular tech companies.
In the first quarter the Chinese government continued its policy support for the domestic job market as well as its business and real estate economic sectors.
The following illustrate the breadth of change in the domestic equity and debt markets over the past three months.
|US S&P 500**
|Barclays US Aggregate Bond Index
**Asset Class Data: JP Morgan, Quarterly Review of Markets
We completed a review of all client portfolios throughout the quarter further diversifying holdings into cyclical and value oriented holdings that may experience less volatility in a market under increasing pressure from inflation and geopolitical concerns. We also reduced international equity holdings giving particular attention to those dependent on the performance of emerging market economies.
Despite the uncertainties of the coming months we remain committed to keeping our client fully invested. It is impossible to time market swings. In an attempt to mitigate losses we diversify portfolio investments across market sectors. Our strategy is to seek to position portfolios to benefit from positive changes that will undoubtedly and inevitably occur.
We tray to ensure there is sufficient cash in individual accounts to address withdrawal requirements as these are required. It is very important that clients communicate to us possible needs for cash as soon as these are known. When raising cash, we seek to time the sale of securities to minimize realized losses as well as limit capital gain exposure in taxable accounts.
 Paola Toschi, JP Morgan Monthly Market Review, Review of markets over the first quarter of 2022.