Monthly Outlook: March 2022
Markets continue to be very volatile and weak in 2022. YTD, the S&P500 is -8%, the NASDAQ is -13%, the International EAFE is -7%, and even Bonds are -3%. It doesn’t feel good, and it raises a lot of uncertainty for investors. Do we buy this dip? Is this the beginning of a bear market? Is my strategy working for me? What’s my downside risk if this keeps going? The key to managing stressful times is to have a sensible plan in place before difficulty arises, to maintain perspective, and to calmly execute your plan. We moved to protection mode in January, using our rules-based iFolios trading strategy, and we’ll stay safe until growth resumes. It’s the only prudent thing to do, for now.
The Stimulus Bubble
The biggest news event is Russia’s invasion of Ukraine last week. The pictures of destruction and loss of life are heartbreaking. We all hope this ends quickly and with the least amount of loss, as possible. As investors, we should note that the downtrends in markets started in January and are the result of something other than Russia. That something is inflation and the inevitable monetary tightening that is coming. If anything, the Russian invasion just contributes to inflation through higher energy prices and supply chain disruptions. We really hope that the Russian-Ukraine story is behind us in a month. But the inflation news story is going to be with us for most of the year.
As a response to the Financial Crisis of 2008, the Federal Reserve (the Fed) did what we would expect from a central bank. They lowered interest rates to 0%, they lowered reserve requirements for banks, and they undertook a new stimulus program, “quantitative easing” or “QE.” With QE, the Fed buys bonds in the open market with newly printed money. That money was supposed to, then, be lent out to create new jobs, build factories, buy homes, start businesses, etc. The Fed increased the monetary base by about $3 trillion from 2008 to 2014. Much of that new money, however, went into the stock market and housing market, driving prices to record high valuations that we’ve discussed before. As the economy and markets recovered, the Fed never unwound the massive stimulus programs, and that $3 trillion of stimulus money stayed in circulation. Then COVID came along in 2020 and the Fed provided a massive $6 trillion of additional QE. This money further fueled the “stimulus bubble” and stocks and house prices soared these past two years. With all this new money sloshing around in the markets and economy, it’s no surprise that we now have inflation, and that’s our new problem.
The Fed’s Job is to Fight Inflation
When the Federal Reserve was created in 1913, its primary purpose was to create and maintain a stable monetary system and to keep inflation in check. Today, we have very high and persistent inflation, no matter how we measure it. Economists use CPI, PPI, and PCE to measure inflation, and they all confirm that we have the highest inflation in about 40 years. The Fed has no choice but to tackle inflation, first by cutting back their bond buying program, and secondly by raising interest rates. This potential monetary tightening is what concerns investors. If the bull market was created by monetary stimulus, could a recession and bear market be created by monetary tightening?
Follow the Price Trend and Invest Accordingly
Of course, no one can really know what the Fed will do, how the economy will evolve in 2022, and whether markets will rise or fall. But we can observe what stock prices are doing by measuring them against their long-term moving average trendline. When prices are zig-zagging higher above their trendline, we say they’re uptrending and should be bought for growth. That’s been the situation for stocks these past two years. Conversely, when stock prices cross over their trendline and zig-zag lower, they are downtrending and can create losses. That happened in January of this year (last month) and is our signal to sell for protection. As we move into March, we are in protection mode, which is the prudent position to take. Hopefully, the Fed will move gradually, tame inflation, and we can resume uptrends and growth very soon. We don’t make the market trends, but we can measure them and keep you on the right side.