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Q1 2022 PastCast: Volatility Returns

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Here’s all you need to know. (If you’re in a rush.)

The Q1 numbers:

  • US Stocks -5.33%
  • International Large Cap Stocks -5.17%
  • Emerging Markets Stocks -5.9%
  • US Bonds -5.92%
  • Energy sector stocks +38.47%
  • Volatility picked up substantially in global financial markets to kick off 2022, with both stocks and bonds declining over the first three months of the year.
  • After a major wave of new COVID cases peaked in mid January, the pandemic began to take a backseat to other economic and geopolitical headlines.
  • Inflation continued to spiral, leading the US Federal Reserve to begin aggressively rolling back its “easy money” policies of the last two years.
  • New supply chain issues emerged due to labor shortages, commodity price swings, and the outbreak of war in Ukraine.
And now for the long(er) version…

As we mentioned in our last update, 2021 was an historically calm year for stocks. That is certainly not the case so far for 2022. In the US, generally positive economic data indicating we are experiencing one of the strongest job markets in half a century, has largely been brushed off by consumers. Of course, this is mainly due to inflation, which has unfortunately hung around much longer than economists had predicted, due to several lingering effects of the pandemic on global supply chains, loose monetary/fiscal policy, and an unforeseen invasion of Ukraine by Russia.

From pandemic to endemic?

Although officially still a pandemic, according to the World Health Organization and others, you wouldn’t know it traveling throughout most of the US at this point. Mitigation measures have been rolled back throughout much of the country and new case counts have plummeted after peaking in January. 

While we’ve been here before, many experts believe that we truly are entering a new phase of the COVID pandemic, in which we learn to live with the reality of COVID-19 being around in some form indefinitely. With a population that has now developed significantly greater immunity through vaccination and/or natural exposure, it seems likely that COVID-19 may transition to a new status of an endemic, much like the seasonal flu. We can only hope! 

Economically, this could mean big things in terms of pent-up demand for things like travel, beginning this Spring/Summer. Consumer demand remains strong even in the face of inflation north of 7%, and rising (for now). On the other hand, sentiment from consumers appears to be waning quickly, creating a very difficult scenario for economists at the Fed, as they attempt to steer the economy through an unprecedented situation without causing a recession – something that may be unavoidable at this point. We’ll have to see.

Ukraine

It’s very difficult to attempt to view something as terrible as the world is witnessing in Ukraine, through a financial lens. These kinds of events remind us all of the freedom and security most of us often take for granted. It actually makes this whole conversation somewhat trivial, if we’re being honest.

That said, it’s impossible for investors to try to form an understanding of things like inflation and decisions by the Federal Reserve Bank here in the US, without considering the very real economic impact the war in Ukraine is having globally. 

In response to the invasion of Ukraine by Russia, increasingly strict financial sanctions have been placed on the Russian economy and Russian leaders individually, by the US and close allies around the world. Since Russia is a major oil producer, these sanctions have caused major price spikes for gasoline virtually everywhere. In an election year here in the US, probably to no one’s surprise, the topic of gas prices has now become a political football, with the expected finger pointing coming from both sides of the aisle, as if it were that simple.

The world runs on oil, and with fuel prices spiking, so too are prices of materials/commodities used to build things everywhere. This only exacerbates the inflation issue nearly every country on Earth is dealing with right now. 

The ending to this particular story won’t be a good one no matter how you look at it. And no one knows how long the crisis will continue. But what once was predicted to be a swift, overwhelming military victory for Russia, has proven to be quite the challenge, thanks to the strength and heart of the Ukrainian people. 

Rate hikes begin

When you think of interest rates, what comes to mind? Credit cards, mortgage rates, savings accounts, all of the above? The truth is interest rates kind of form the foundation of our entire financial system. Control over short-term lending rates is a powerful tool the Federal Reserve Bank has when it comes to monetary policy.

The Federal Reserve has two goals or “mandates”, as they refer to them: High employment (low unemployment), and stable prices (low inflation). 

A quick review of how we got here: As lockdowns began in the Spring of 2020, unemployment saw one of the quickest, most severe spikes ever recorded, leading many to fear that we may have been on the verge of throwing ourselves into a pandemic-induced 21st century version of the Great Depression. 

In response, the Federal Reserve took unprecedented steps to inject money into the financial system and incentivize businesses to spend and borrow, largely by taking interest rates nearly to 0%. 

At the same time, Congress passed several spending bills that included direct relief payments to individuals and families, student loan forbearance, rent/mortgage moratoriums, among other things, in order to mitigate the economic impact of the pandemic, especially for those that found themselves unemployed. 

In hindsight, it’s hard to deny that the response from our government and Federal Reserve worked incredibly well, as we are already back near full employment just two years later, on the back of the strongest jobs market we’ve seen in generations. 

On the other hand, these decisions come with trade-offs, and we are now feeling the effects of this unprecedented policy response, via inflation. Historically, the cure for high inflation has nearly always been a recession. And although the Federal Reserve would never say it out loud, one way to induce a recession is to quickly increase interest rates, to cool down the economy and stabilize prices for consumers.

“There are no solutions, there are only trade-offs”

-Thomas Sowell, Economist

So now, as the Fed has been warning for some time now, interest rates have begun to rise and will likely continue to rise quickly throughout the rest of the year. In the short-term, this has caused both stocks and bonds to dip into negative territory, which is a pretty rare phenomenon. But as long-term investors, perspective is so important here… 

Bonds are currently experiencing one of their worst periods of performance EVER. And what has that translated to so far? A -5.92% return year-to-date for US bonds as a broad group. Bad bond performance is simply not comparable to what would be considered bad performance for stocks, which tends to be far worse on the downside when things get bumpy. So, we remind you that as painful as negative returns are, holding bonds in your portfolio is about much more than returns.

When it comes to stocks, US stocks ended the first quarter down just about 5% as a group, which technically doesn’t even qualify as a correction, although they had dipped much lower than that in February, before recovering some in March. 

Considering everything happening in the world at the moment, it’s actually somewhat shocking how well the US market has held up this year, so far.

Key takeaways this quarter

Year in and year out, investors rarely have to look hard to find something to worry about, whether right now, or just around the corner. As an investor, it’s crucial to learn that you simply cannot control or predict market reactions and you also cannot control the timing of geopolitical events and other market shocks. 

What you CAN control, is your ability to stick to your own personal investment strategy. Being able to stick to any strategy means understanding what that strategy is and how it is tailored to benefit you and your path toward your goals, especially in times of market turmoil.

If you’re someone counting your years until retirement in decades, we’re going to be recommending some heavy exposure to stocks in your portfolio. We do this with the assumption that pull backs, corrections, and even crashes, are somewhat likely to occur at some point nearly every year. It’s pointless to try to predict the “why”. When we operate under that assumption and hold onto that expectation, it becomes much easier to view lower stock prices as the opportunities they historically always have been. And it also reframes negative short-term performance as a good thing in the long run. After all, with decades of time on your side, why would you want to consistently buy stocks at higher and higher prices? You actually NEED the declines in order to get the higher returns stocks tend to provide. That’s what stock investing is all about.

On the other hand, if you’re someone who’s retirement is just around the corner, it’s reasonable to feel a much greater sense of panic in times of uncertainty. But just like the aggressive investor above, your recommended strategy has built in the same expectations. The difference comes in the actual investments that make up your recommended portfolio. A more conservative approach means less exposure to stocks and more exposure to bonds. While both have struggled to kick off 2022, you are likely going to have a much smoother ride during this period. 

Bonds are complicated, to say the least. But at a high level, higher interest rates mean higher rates on new bonds being issued, which translates to higher interest payments for your bond funds in the long run, despite some short-term pain. And maintaining some stock exposure is still important for the growth component of your nest egg, in order to ensure that you don’t outlive your money IN retirement. 

No matter your personal situation, tuning out the short-term noise as it relates to your retirement savings, is far more difficult than it sounds. That’s what blooom is here for. Please remember that our advisors are ready to help you understand the strategy we’re recommending for you and we’re here to talk through your concerns when you have them. 

 

The information is provided for discussion purposes only and should not be considered as advice for your investments. Past performance is no guarantee of future results. Please consult an investment advisor before you invest.

Published on April 20, 2022