Well, that was fast
There’s no comforting way to state that this is broadly the worst start to the year for investment performance since 1970. The combination of high inflation, middling real growth, and rising interest rates has left major equity indices down 20-30% YTD, while bonds have also seen their worst performance in ~50yrs, down 10-15% YTD. It’s incredibly rare to see those two things happen at the same time, as they often have minimal correlation (or even negative correlation during times of uncertainty). There has been nowhere to hide, other than unique commodity prices that have shot up, mostly from the effects of Russia’s invasion into Ukraine in February. While it looks like US inflation has potentially peaked in the near term, there is no end in sight to the war in Ukraine, and commodity prices could remain generally elevated for some time; all of this has sparked the Federal Reserve to take a more aggressive stance on interest rate increases than they have in the past.
This is in stark contrast to their less concerned stance at the end of last year, and this rapid shift has cratered equity and bond prices. The Fed’s policy change potentially causing a “hard landing” (ie a major slowdown in economic growth in order to stem rabid inflation) instead of a “soft landing” (a gentle slowing of growth while successfully taming inflation) is what has scared markets so far this year. In opting to choose the freezer to fast-chill this carbonated beverage rather than the fridge, the concern is that it may now explode.
The good news is that a significant portion of the Fed’s projected interest rate increases have been priced into the market (roughly another 2%). That means that it’s possible that the majority of equity volatility is also past us.
The bad news is that there’s no real precedent for the Fed to follow in order to ensure a “soft landing”. Imagine for a minute that you’re playing in the National Egg Toss Championship (apparently this is a thing). You want to make sure to catch the egg so that it doesn't hit the ground (tame inflation with higher interest rates), but you also don’t want to catch it so firmly that it gets crushed in your hands (stem inflation so aggressively that it crashes the economy). Unfortunately, the Fed skipped field day, so they’re playing this game for the first time. And with egg prices up 11% from March 2021 to March 2022 (and your July 4th bbq up ~17%), they can’t really afford to break any eggs.
While it’s foolish to make bold predictions on what will definitely happen to the economy and markets, we need to be prepared for likely outcomes. These will directly affect student loan/mortgage rates, cash holdings, investment performance, portfolio allocation, withdrawal timing, and taxes (just to name a few).
We are bracing for a hard landing, where the Fed focuses intently on bringing down inflation at the risk of pumping the brakes too hard on the economy. This means a bigger, possibly longer slowdown, potentially increased volatility and asset depreciation, and likely disruptions in the labor market. This isn't guaranteed to happen, but it's certainly the biggest risk. As I mentioned in our blog last week, we are already witnessing a unique change in the labor market, where there is still a Covid-driven dearth of low-skill labor supply (coupled with strong/increasing demand), but simultaneously the beginnings of a slowdown for high-skill labor demand for fear of an impending economic slowdown. Covid cases with the newest BA.5 variant are on the rise, making it harder to find sufficient supply of the former. And Tech companies such as Tesla, Netflix, Unity Software, Coinbase Global, Stitch Fix, and Redfin have already announced job cuts, while Twitter and Intel are among a host of companies that have imposed hiring freezes (this is now widespread across the world of startups). Facebook parent Meta issued a chilling message to employees, saying that they face one of the “worst downturns that we’ve seen in recent history” that will require scaling back hiring and resources." CEO Mark Zuckerberg told employees that they would be expected to do more with fewer resources, which is a sentiment being echoed across corporate management.
While we're always looking for investment opportunities that can mitigate these risks, intimate knowledge of client cash needs and investment time horizons allows us to ride out turbulent markets like this and come out better on the other side, whenever that may be. There's no way to time markets, so we'll do everything else we can to prepare and prosper.
As always, we will remain vigilant for the undoubted volatility to come and continue to look for strategic opportunities when available. If you have any material changes to your situation that we haven't discussed yet, please reach out to schedule a call soon. Otherwise, we'll continue to shoulder the stress of short term volatility in the hopes that you can enjoy an amazing (albeit more expensive) rest of the summer!
Best,
Rohit