Dear Clients and Friends,
This could be one of the most volatile weeks the world has seen since 1945, as reflected in disconcerting headlines and gyrating stock, bond and energy markets. But all is not lost, and in sifting through news cycles and research blogs, we are embracing opportunities provided by this uncertainty and remain confident in the relative stability of the financial markets.
The Ukraine war may well mark a new epoch for Europe and the world, but just five days in, it’s too soon to be certain about its enduring ramifications—though it’s safe to say that Vladimir Putin’s reputation as a thug and a warmonger is now cemented in history. The fact of the matter is that from an economic perspective, both Russia and Ukraine are insignificant participants in the US economy, though are more impactful in a more vulnerable Europe.
While staying aware of the current tumult in the world, and in concert with our ongoing concern for the people of Ukraine, you can expect us to remain steady stewards of our clients’ investment capital. Following is a brief, timely and valuable (we believe) overview from one of our money managers. Columbus Macro CEO Craig Columbus shares his perspective and focuses exclusively on the market and economic impacts of the developing situation in Ukraine. Columbus Macro - Ukraine Impacts
Regardless of how the Ukrainian conflict turns out, to me it seems the dominating issue for the markets will be the Federal Reserve and inflation. For the markets and the U.S. economy, commodity prices and oil were already moving higher before the conflict and certainly those tensions are adding a further premium to energy prices. But rising commodity prices are only a part of the inflationary impulse impacting the Fed and monetary policy dynamics.
The Federal Reserve’s James Bullard’s view is that inflationary pressures in 2022 are also coming from the strong re-opening of the economy. He believes that the US economy looks to be growing at close to twice its longer-run trend. Bullard also believes the unemployment rate could drop below 3% this year—which would be the lowest level going back to the 1950s. Optimistically, Bullard believes the low rates on the 10-year bond shows confidence the Fed will control high levels of inflation over the longer run. I’d remind readers that the market has a bad history of pricing long-run inflationary dynamics and there was a 30-year period from the 1950s to the 1980s where bonds had negative after-inflation real returns. That tough 30-year bear market reversed in 1982 to set up the 40-year bull market in bonds we’ve had since then—but that bull market in bonds now appears to be over.
Of comfort to the equity markets in the near term, due to the current global conflict, I believe the Federal Reserve and the European Central Bank will proceed more cautiously in terms of tightening monetary policy. Both will likely wait to see how financial markets and commodity prices react to both the Russian invasion and incoming data on inflation. Ultimately, I think the Fed will raise interest rates but perhaps do so more gradually than markets anticipated a week ago.
In summary:
- The situation in Ukraine is tragic and Putin is a criminal, yet outside of headline shock, the US economy remains relatively insulated. The exception to this is higher energy prices and continuing supply chain woes which could in the coming months prompt a possible pull-back in consumer spending and corporate profits. This could restrain any meaningful gains in equities for some time.
- Strong growth is a blessing as well as a curse (sounds odd, but true). Interest rates are headed gradually higher, and day-to-day market volatility will remain high based upon Fed actions or inactions.
- While we expect positive but muted US equity returns for years to come, we do not expect a dramatic decline either. With stock valuations already having pulled back anywhere from 10%-50% sector dependent, overall equities are now more “fairly-valued” and not as stretched as they have been for the past many months.
- With interest rates climbing from historic lows, and the US stock market having provided over-sized returns for the past 12 years, we believe the traditional “60% US stock / 40% US bond” portfolio allocation strategy to be a relic. It is time to consider partial reallocation to those asset classes that have underperformed for many years.
- What to do now? We remain committed to diversifying portfolios taking a “barbell approach”. On one end we have a globally balanced portfolio of low-duration bonds, value-oriented equity managers and inflation-sensitive managed futures, commodities, and real estate funds. For investors seeking a more aggressive posture, the other side of the barbell is more opportunistic, featuring equity funds in innovative technologies that will change the world.
We hope you found this update to be of value and are available should you have any questions. Please be in touch.
Bob Webster and James Keller
The views stated in this commentary are not necessarily the opinion of First Allied Securities Inc. and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.