Market Update January 18, 2022
Like a bear coming out of hibernation, the Federal Reserve seems to be waking up to the fact that inflation will not be transitory. Fed Chairman Jerome Powell acknowledged at the end of November that “it is probably a good time to retire that word.” I shared my concerns about the Fed continuing to provide extreme economic stimulus more than 12 months following the March 2020 market plunge in our “Transitory Inflation?” blog last May. The Fed’s reputation for creating as many economic and financial market bubbles as it fixes lives on.
By keeping interest rates low during an accelerating economy, inflation has skyrocketed and the real yield of the Federal Funds Rate and the 10 year Treasury bond (meaning yield minus inflation) are well in negative territory. They are now at their lowest level since the mid 1970’s. This implies an incredible level of stimulus, and during a strongly growing economy at that. The result has been a boon for U.S. stock market returns as earnings shot far past what were already optimistic earnings estimates. The danger is that their great return in 2021 comes at the sacrifice of future returns as the Fed turns its attention now to staving off inflation. The Federal Reserve is in the process of winding down their $120 billion a month in Treasury and mortgage-backed securities purchases, and expectations are that they will begin raising the Federal Funds rate in March.
The turbocharged S&P 500 was again hailed king of the global financial markets in 2021, up 28.7% for the year. The return of foreign stocks was much less sanguine, with the MSCI EAFE index of established foreign economy stocks up 11.3%, and the MSCI Emerging Markets index ending the year down 2.5%. Bonds had a rough go in 2021 as well, with the Bloomberg US Aggregate index down 1.5%. The end result is that if someone was 100% in domestic stocks last year they likely had a banner year. For prudent investors maintaining broadly diversified, balanced portfolios (meaning holding bonds too), returns were more subdued. Adding to the bizarreness of last year, investments that historically have done very well during periods of rising inflation – such as precious metals and the aforementioned emerging market stocks – had some of the worst returns among the various asset classes. Growth stocks again dominated value stocks for much of the year, despite value’s propensity to shine during periods of rising inflation. I do not believe it is a matter of if some of these market segments will take over leadership, but when.
In a bit of good news for many investors, the IRS has issued new life expectancy tables for calculating required minimum distributions (RMDs) from retirement plans, effective beginning this year. Investors age 72 and above with pre-tax retirement plans are required by the IRS to draw annually from these types of accounts. This table update is the first in 20 years. The change results in a small decrease for most investors in the amount they are required to draw, giving them the opportunity to lower their tax burden, retain assets, and increase what they will eventually leave to their heirs. Note that this change does not apply to non-spouse beneficiary IRAs.
So where do the financial markets go from here? While it’s anybody’s guess, I believe higher volatility is a given as the markets digest the Fed’s shift to tightening. Long term bonds are very vulnerable in a rising interest rate environment. Higher inflation has also tended to weigh on stock valuations, making the richly valued growth stocks more vulnerable than lower valuation stocks. While rising inflation and interest rates do typically weigh on valuations, stocks generally have been a good place to be invested due to corporate earnings rising with inflation. The caveat to this is that rapid increases in inflation could lead the Fed to aggressively raise interest rates, which historically has led to volatility in stocks.
If this month’s market action is any indication, perhaps this will be the year we finally see a shift in leadership. 2022 is off to a rocky start, and foreign stocks have held up much better than domestic thus far, as have value stocks relative to growth. The financial markets are inherently unpredictable, hence the merit of sticking with a prudent long-term strategy. Do not hesitate to reach out to me if you would like to revisit our strategy for your investment portfolio.
Sincerely,
Glenn S. Rank, CIMA®
Certified Investment Management Analyst®
President
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· The S&P 500 is an unmanaged index of 500 widely held stocks that’s generally considered representative of the U.S. stock market. The MSCI EAFE index and the MSCI Emerging Markets index are unmanaged indexes compiled by Morgan Stanley Capital International that are generally considered representative of the developed international stock market and emerging international stock market, respectively. International securities involve additional risks including currency fluctuations, differing financial accounting standards, and possible political and economic volatility, and may not be suitable for all investors. Investing in emerging markets can be riskier than investing in well-established foreign markets. Investing in small cap stocks generally involves greater risks, and therefore, may not be appropriate for every investor. The Bloomberg US Aggregate Bond Index is a broad base, market capitalization-weighted bond market index representing intermediate term investment grade bonds traded in the U.S.. Inclusion of these indexes is for illustrative purposes only. Keep in mind that individuals cannot invest directly in any index and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor’s results will vary.
· Precious metals markets can be volatile and may not be suitable for all investors.
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