Monthly Outlook: April 2022
It’s been a volatile ride for markets in 2022, so far. The high of the year was on January 3rd and it’s been down, up, down, and so on, for three months. The S&P500, for example, lost 10% in January, bounced back 7% in February, lost 9% again in early March, and then recovered 10% in the last two weeks of March. Importantly, it reversed trend (above or below its 200-day moving average) four times. This volatility is not unheard of, but it is rare. Investors are acting like nervous chickens and waffling in their conviction. Let’s agree to call this a “chicken & waffles” market, and it’s anything but comforting.
Looking across asset classes, or markets, we see a mixed bag of trends as we start Q2. Bonds, usually held for stability and income, have been weak this year, with a loss of 5.7%, including interest. US Small Companies, INTL Growth, and Emerging markets are all downtrending. Some good news, and uptrends, can be found in US Value and INTL Value, mostly due to strength in the Energy and Healthcare sectors. So, there are a few markets that are worthy of investment, but it should be noted that Cash is beating many markets this year and is a suitable hold for now.
Inflation – the Pin that Pops the Bubble?
So, what changed in 2022? After all, most of the economy is running hot, unemployment is at a record low 3.6%, businesses are wide open and busy, and earnings are good. Markets were great for the past two years and the trends rarely changed. When COVID first shocked us all in February 2020, the S&P500 dropped 30% in five weeks. But with the help of massive, unprecedented, stimulus programs, the S&P500 quickly recovered the drop in just three months. It was amazing. Congress came out with multiple fiscal programs, PPP loans, and tax cuts. The Federal Reserve (the Fed) slashed the Fed Funds rate to 0% and embarked on a Quantitative Easing (QE) program unlike anything ever seen in history. The Fed, through QE, effectively pumped another $5 trillion of new money into the economy and markets. During the COVID shutdown, much of that money couldn’t be spent, but it did find its way into financial assets, ranging from stocks to bonds to high-end housing. The Fed created its own bubble, and it created the inflation that we have today. It took a couple of years, but we’re now facing the reality of too much “free money” in the system. Inflation is running at 6% to 10%, depending on whether you use CPI, PPI, or PCE, which is a 40-year high. The Fed was wrong in thinking that inflation was “transient,” and we all know that it’s more persistent and real than previously thought. The Fed has no choice but to take aggressive steps to tame inflation and they’ve explicitly said they would do so. They took the first step last week by raising the Fed Funds rate ¼% and are likely to raise it at every one of their six remaining meetings this year. Additionally, they’ll begin Quantitative Tightening (QT) to slowly unwind the $5 trillion they recently printed.
Risk of Recession?
Today, the economy feels very strong and discussing a possible recession seems premature. But that’s what investors seemed to be worried about. One very useful recession indicator is called “the inverted yield curve.” This is when short-term interest rates are higher than long-term interest rates. The yield curve has inverted before every recession since 1950. In March, the yield curve did invert, signaling a recession is likely sometime in the next six to 18 months. But, it’s worth noting that markets often continue higher initially after the inversion and that might be where we are today. A real bear market in stocks usually starts when the yield spread widens again, after inversion, and we’re not there yet.
How to Navigate Your Portfolios Now
We’re at an important inflection point for managing portfolios. Stock valuations are high, the Fed is tapering its stimulus, consumer sentiment is softening, and recession indicators are flashing “yellow.” Today, our indicators tell us to remain about 75% invested, and to hold a bit of cash for safety. We’re still in growth mode, for now, and might be for a long time. But we’ll remain vigilant, and willing to sell to be more protective if the need arises. We fared very well in the last 2008 recession and are ready to do it again. These are the markets where our iFolios strategy pays off.