You know you are getting older when you start to say, “I remember when I saw this before.” In the first quarter of 2022, I have been saying that a lot. For almost the last 10 years, the economy and markets have generally been in a time of a low inflation, low interest rates, accommodative Federal Reserve, high-earnings growth and moderate GDP growth. The S&P 500 has been up over 10% in eight of the last 10 years. Things have been good. Now we have even weathered a global pandemic over the last two years. You would think the economy and markets would struggle but guess what? The Fed dumped in over $4 trillion of cash and things turned from negative to positive quickly.
A Projection of What’s to Come
If you regularly read our letters, you will know we have been saying the path we have taken will eventually come with a price. The bill is now due. It will have a dampening effect on the economy but at this point, we don’t think it will kill it. Here are some of the things we project may be the outcome:
- Higher interest rates —The Fed may raise rates 4-5 mores times this year.
- The Fed will continue to taper bond purchases.
- Inflation is now at 7.9% and will back off by 4-5%. The more transient inflationary factors will fade and Food, energy and wage inflation are the concern.
- GDP will grow nicely at 3% but slower than before.
- Unemployment is down to 3.6% and dropping.
- M2 money supply has been up 40% over last 2 years, thus money that was spent just appeared out of thin air. This created a demand shock we are still unwinding from. Will take more time, thus high inflation is short term.
- This inflation will harm consumers as wages tend to grow slower than inflation. Currently 32% of workers make less than $15 per hour which will greatly impact their buying power.
- We’re still in an economic expansion because of strong household balance sheets, elevated consumer spending, rising wages and low unemployment. We believe this can continue for some time as long as the Fed is successful in a soft landing and stays ahead of rising inflation.
- We’re still upside in U.S. markets. The Ukraine/Russia conflict heightened the risk of a recession in Europe. Foreign markets are cheap but might be a little early to dive into. That day is ahead sooner than later though.
- A few things that are attractive to buy now:
- Energy & Commodities including Agriculture
- Only about 28% of S&P 500 are in these sectors.
- Expect leadership to stay shifted from growth to value.
- Fixed income will be tough near-term but still find returns in floating rate credit, private credit and municipal debt.
There’s Hope in the Challenges
Sounds like a lot of things to be concerned about, right? Many things are changing and what made money over the last 10 years may not be the leaders in the next 10. The U.S. economy is still very healthy and robust. Even though we may be slowing down with interest rates and taxes up, we don’t believe the party is over. It’s just a different kind of party than we are used to lately. Here is the thing many of us are old enough to say: We have seen this before and there were challenges, but it all worked out OK.
Gregory B. Pierce, JD
President and CIO