Recently all eyes have been on the stock market and the Federal Reserve. After the Fed’s meeting last week that resulted in two interest rate hikes, equity markets and bond markets have not fared too well. The 0.50% basis point move was the first time two rate hikes occurred at a single Fed meeting in over two decades. Investors are uncertain about the economy’s continued growth and whether future rate hikes by the Fed will lead to a recession. This in turn has led to the future earnings growth of major companies in stock indices, such as the S&P 500, to have lower expected profitability in the coming quarters. Though the broad market is feeling some pain, others have felt it worse, like in the valuation of certain “high-flying” companies – those that have had prospects of high future growth – in other words, not yet profitable or low profitability but still valued such that their future profits are priced-in to ramp up in the future.
There are several reasons for the anticipation of slower or weaker economic growth. One reason is that inflation data releases have continued to show an uptick, and economist forecasts estimate that inflation will continue to increase. However, that no longer appears to be the trend. The next inflation report is scheduled to be released this Wednesday, and estimates show that inflation may well have peaked. Both Year-over-Year and Month-over-Month estimates of the Consumer Price Index (CPI) show that inflation is expected to fall. Though the drop is not large, inflation has been increasing throughout the entirety of 2021, and the comparisons to year-ago-data is going to prove hard to show the same level of increase throughout the remainder of the year.
The Fed’s goal is to have stable employment and tame inflation. So, to bring inflation closer to their 2.0% target, they will need to carefully manage the pace and scale of interest rate hikes over the remainder of their 2022 meetings (there are five more Fed meetings in 2022). We have not seen such high inflation in decades, and at first, the Fed welcomed it. They were playing catch up since they have undershot their inflation target for the greater part of the last decade. But now, there are concerns that inflation has got too high. The risk investors fear is that rate hikes will induce a recession. But gradual rate hikes are not bad as long as inflation comes under control. So, while economic growth is expected to bounce back in the next quarter following a negative GDP print in the first quarter of this year, there are still fears that we may fall into a recession as a result of the Fed’s rate hikes. Though we believe a recession will only be a technical recession at best (two consecutive quarters of negative GDP releases).
The question remains, what factors will help improve the economic outlook for the remainder of the year? In the near term, this Wednesday’s CPI print will be important as the expectation is that we will see a decrease in inflation. The inflation print will surely play a role in the Fed’s rate hike decision at the next Fed meeting occurring in June. Throughout the remainder of the year, supply chain issues should they alleviate, will be a tailwind for growth as supply chains normalize and price pressures fall. On the labor market, the combination of tight inventories due to tight supply chains, high consumer spending in the services sector, and the increase in wages have led to aggressive hiring and low unemployment, but this gives more reason for the Fed to hike interest rates to cool the economy without risking a major economic slowdown.
The turbulence investors have seen in equity and fixed income markets over the past few weeks leads us to one question. What do I do? Do I do nothing? That is easier said than done. For younger investors – do not sweat it; this is a great time to buy. If your time horizon is 10+ years, doing nothing is okay as well – the ebbs and flows of markets turn into a blip in the grand scheme of things. So then, all that needs to be of concern is cash needs in the next year or so; if you have a shorter horizon and have a large allocation to stocks, it may be ideal to do some tax planning and take some tax losses. What about new investors? The obvious question is when to go in with your money and invest? If investors only invested in days of good news, surely their returns would not be as great as those who invested more when the bad news rolled around, i.e., when securities were cheaper. Though, the best thing to do in volatile times is to stick to your financial plan.
– Jose Rendon
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