Since last November when the Federal Reserve said they would raise rates, the markets began to price in those expected higher interest rates, and companies likewise priced in on balance sheets and forward guidance, as is standard. The markets initially gyrated down with the expectation that rates would rise and money supply would be reduced, ending the equity party that’s been going on for years. That said, after a few weeks of adjustment, the markets popped back up to near all-time highs and at end of the year.
Turn the page to 2022, and on the second market trading day of the year, market participants were informed that there might be four, five or six rate hikes in 2022 instead of three. By the next week, they were hearing that it could be seven, and by the third week of January, suddenly Fed watchers were projecting eight or nine rate hikes for 2022! With that, many market participants asked again, is the party over?
While there was no actual proof of what the Fed would do, there was much concern that the easy days of cash-out refinancing to fix up a deck, install a pool or remodel a kitchen would become a thing of the past. This caused the equity markets once again to gyrate lower – despite strong corporate earnings and guidance for 2022 – which caused even more worry and led to more volatility.
In case you’re wondering why I left out the supply chain disruptions that we’ve been dealing with since Covid, well, those were all issues that we’ve covered back in 2021, and while they’re still prevalent, the marketplace has priced in the initial issues of restarting the economy. The tell-tale sign here is that we’ve seen large inflation numbers over the last few months. Or, in real-world terms, the patio furniture I want to order for my back deck may have to wait, as it’s doubled in price. All costs including the man-power to manufacture, package, ship, truck, and deliver, combined with current fuel costs have spiked, so it’s no wonder everything is more expensive.
But back to the story. We found ourselves faced with the news on February 24 that Russia had invaded Ukraine. Believe it or not, for the first five days, equity markets rallied as the perception was that Russia would run roughshod over Ukraine and the world would go on as it had. However, people started realizing that the Ukrainians weren’t so helpless after all. They’d also been aided by some of the super powers with defense systems, as well as drones from every start-up US-based military drone maker that wanted to prove itself in action. As soon as the markets realized this was going to be a longer conflict, things gyrated down. Remember: uncertainty is the one thing the market despises most.
As the war continued, we turned our attention back to our own Federal Reserve who, along with other global central bankers, began raising our interest rates. The fear once again turned from nuclear war (or war in general) to our economy and how we would handle these rate increases, and how many increases the Fed would need to make as we continue to see inflation numbers that boggled the average person’s mind.
We now have central bankers around the world trying to raise rates and quell inflation, while at the same time, we have an active war on European soil. This combination has never happened before in the history of the world. Toss in the fact that nearly all major brands and service providers have cancelled Russia, removing their business and shutting down any Russian offices, resulting in a reduction of goods around the world. And, Ukraine – the world’s bread basket – won’t be able to harvest their crops, likely resulting in a commodities squeeze we haven’t seen in decades. The result isn’t so much a supply chain issue as it is a scarcity of supplies in the first place.
As Russian cancel culture became more and more prevalent, energy prices spiked along with corn, wheat, and natural gas, peaking at near 52-week highs out of fear of scarcity. This pressured the equity markets even more, because on the one side we want to slow down inflation, but on the other side people need to be fed. Prices at the gas pump skyrocketed. As of this writing, oil prices have come down to within $5 a barrel of pre-Russian invasion prices, but our price at the pump hasn’t dropped and I don’t expect it to. We’re heading into the summer travel season after all.
To sum up, this craziness in the market over the last 10 days has been driven by concerns about high inflation, and fears that the Fed, while able to slow the economy, lacks a “magic pill” to make up for scarcity of commodities should the Russian/Ukraine conflict head into 2023 and beyond. The final shoe to drop? Oh yeah! China has Covid again!
And just like that, we’re back in this news cycle of Covid slowing down the world, war leading to scarcity, and central banks around the world (including our Fed) wanting to slow inflation.
Something has to give, and I don’t think it’s going to be our Federal Reserve. Of course Covid could vanish come summer. But, we’re also going to hear from every company that cancelled Russia and may therefor pay less taxes due to Russian write-offs, making it look like revenue is declining at the same time the Fed is making everything more expensive.
We probably won’t break this cycle until 2023. Until the market believes that the Fed and other banks around the world can control inflation, there won’t be confidence in this market. As always, I’m happy to answer any questions you have about the current economy and your portfolio – just give me a call.
Article by David Smyth, Senior Partner at Family Financial Partners — a financial services firm in Lexington, Kentucky.
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