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Interesting Times

Interesting Times

May 27, 2022

As they say, “May you live in interesting times”.  Russian forces invading Ukraine, oil prices skyrocketing, and market gyrations through the first 5-months of the year have created plenty of uncertainty. Let me provide some perspective as to why the markets have moved, where we are today, and a few thoughts for optimism at this point.

We believe the pullback in the stock and bond markets are a result of expectations of interest rate increases combined with a tightening of the Federal Reserve’s monetary policy. Both stocks and bonds have reacted negatively to the expected rising of interest rates. We began the year with the US 10 Year Treasury near 1.5% and now, mid-May, we are nearly 3.0%. This increase in interest rates was driven by the market in anticipation of the following Federal Reserve actions:

  1. Raising of the Federal Funds Rate (a short-term interest rate),
  2. Reducing the open market activities of the Federal Reserve’s bond buying programs (Quantitative Easing), and
  3. Fears that the Fed could reduce the balance sheet and begin selling bonds (Quantitative Tightening), effectively creating more supply and driving rates up.

This combination of anticipated Fed actions led the market to re-price interest rates in the market and, in turn, valuations of the stock markets have re-priced as well.

The US reported negative 1st quarter real (inflation adjusted) GDP. According to Bloomberg’s most recent survey, economists put the odds of a recession starting sometime in the next year at 30%. The economists that I trust the most suggest that it is further out on the time horizon and expect that the real GDP for 2022 to end the year in the +2.00-2.75% range.

Given the market sell-off of stocks, the precipitous declines in the bond market, and CPI at 8.5% where can we go with our investment portfolio from here? I’m optimistic for many reasons, and I believe that remaining invested is paramount to the long-term success for investors. The following are my reasons to stay invested:

  • Higher money supply increases the demand for all things – goods, services, and assets. To that end, it is reasonable to see why real estate prices have boomed over the past two years
  • Stock prices are trading at 16.7x forward earnings, a fair valuation metric based on historical P/E standards over the past 25 years
  • Earnings growth is projected at 10% for the year, and are projected to grow through 2024, which could lead to positive equity market returns over the coming years
  • S. Corporate Bond yields are now at 4.4% (well above the 1.9% lows over the past year)
  • Investors can buy I-Bonds directly from Treasury Direct that are currently yielding 9.62% (albeit in restricted amounts of $10k per person)

*Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

All investing involves risk including loss of principal. No strategy assures success or protects against loss.

The economic forecasts set forth in this material may not develop as predicted and there is no guarantee that strategies promoted will be successful.