Q2 2022 Quarterly Newsletter
This past week marked the ending to another volatile quarter for investors, where we saw US stocks decline another 17%, international developed and emerging markets each decreased 15% and 11%, respectively, and even bonds dropped 5%. Inflation, however, remains the focus as the Fed continues its aggressive interest rate increases to battle the worst inflation we’ve seen in some 40 years. Strangely, however, the unemployment rate sits at 3.6%, which is very low, and has actually decreased since the beginning of the year. If the US is now in a recession (which is generally pronounced after the fact) it will be the first time since World War II that we entered a recession with a falling unemployment rate…it’s a strange time to be an investor, indeed.
I believe we’re approaching a fork in the road. Once inflation is brought under control, this fork would set us on one of two distinct economic paths and it's worth discussing what the economy would look like under these economic conditions.
The first option is that after inflation is brought under control, interest rates edge back down towards the historic lows we experienced during much of the past 13 years. This ‘Secular Stagnation’ is characterized by low economic growth and low inflation despite low interest rates. Under this scenario we return to the investment strategy that benefits from loose monetary policy, some examples of which include expensive tech stocks, hard assets and long-term bonds.
Another option is that the economy returns to more historically normal economic conditions (higher growth and higher inflation despite higher interest rates). Inflation settles at a level closer to the historical average of around 4%, rates stay elevated (relative to what they have been) and economic growth is able to cope. Under this scenario we return to an investment strategy that is competitive in higher rate environments like value stocks and shuns hard assets and no-yield investments like precious metals and currencies.
My belief is that once inflation is brought under control, which admittedly could take some time, we enter the second scenario with elevated inflation and interest rates. I personally think some meaningful level of inflation is here to stay and that the economy is going to have to work around this new reality. That said, there is no way that I, or anyone, can accurately predict changes in the economy or market. Our client’s evidence-driven portfolios are structured such that whatever path the economy takes, we can benefit from its long-term growth. As I discussed in our Q1 2022 Quarterly Newsletter, our portfolios are built with 5 key common factors in mind…(1) global diversification, (2) modest small/value tilt (3) minimal credit risk with short maturities (4) institutionally managed asset class strategies and (5) minimal expenses and tax.
In closing, our work together must revolve around the continual development and refinement of your Plan, the economic framework that guides you through turbulent times like these. As I discussed in our Market Update for May, three principles on which your Plan is built are (1) plan for the unexpected, (2) diversification works and (3) invest for the long term. As we move through this 3rd quarter, adhering to these principles will be key to ensuring our success together.
-Andy