LCK Wealthlete: 2022 Second Quarter Market and Economic Outlook

By Kendall Duncan on April 11, 2022

Global Financial Market Performance year-to-date through March 31, 2022

Source: Bloomberg

Performance was challenging across global financial markets during the first quarter of 2022. Both stocks and bonds were down, which Strategas notes is relatively rare having occurred just 19 times of the 185 quarters since 1976. The quarter began with steep declines in January and February followed by a partial rebound in March. Negative performance during the quarter is largely attributable to rising inflation and geopolitical conflict leading to a surge in commodity prices that resulted in the first rate hike by the Federal Reserve since the beginning of the pandemic.

During the first quarter we found the brutal war in Ukraine is not only devastating on a human level but is also accelerating a shift away from globalization, which in turn leads to higher inflation and lower real returns on investments. As Larry Fink the CEO of Blackrock put it “The ramifications of this war are not limited to Eastern Europe. They are layered on top of a pandemic that has already had profound effects on political, economic, and social trends. The impact will reverberate for decades to come in ways we can’t yet predict.”

The initial economic impact of the Russian invasion of Ukraine and related sanctions appears less severe than some had feared. The US has been buffered by robust economic fundamentals such as low unemployment, consumer balance sheet strength and a fading pandemic with Q1 2022 quarter-over-quarter GDP growth expected to be 1.5%, according to Bloomberg. Europe, on the other hand, is expected to grow 0.3% over the same period because it suffers more direct economic damage from the war as a sharp rise in fuel and input prices hurts consumer demand and industrial production.

While we expect the economic recovery to continue, it will likely slow for the full year 2022 but remain above trend. That is, GDP estimates for the World and US are being revised down while inflation is being revised up, according to Bloomberg.World and US GDP grew 5.9% and 5.7% in 2021 and is expected to grow 4.0% and 3.4% in 2022, respectively. Those private forecasts are below official forecasts of 4.4% and 4.0% as private forecasts more quickly reflect geopolitical risks. Longer term, we expect US growth to moderate towards its long-term potential of 2% due to secular factors, such as high debt levels and ageing demographics.

Inflation, as measured by CPI, was up 4.7% in 2021 and is expected to increase 6.2% in 2022, which was revised up from 3.3% at the start of the year, according to Bloomberg. The cost of shelter, in particular, is rising rapidly with the S&P/Case Schiller housing prices up 18.8% and, according to the Redfin real estate brokerage, rent was up 18% over the last two years. Over the long term, structural factors such as aging demographics, high global debt levels, and the disinflationary impact of technology and innovation will likely bring inflation closer to central bank targets.

The recent increase in inflation began because low interest rates, large fiscal stimulus, and pent-up demand as pandemic restrictions eased led to surges in consumer demand and rising prices. Then the global supply chain struggled to normalize as a surge in COVID-19 cases in China led to factory shutdowns and the war in Ukraine severely disrupted supplies of food, oil, and other commodities. The combination of those factors suggests that inflation could be high for longer than initially thought.

The Federal Reserve, in response to lingering high inflation, says it is ready to take stronger action if needed to curb inflation. It is expected to raise rates by 50 basis points at each of the next three policy meetings and start reducing its $9 trillion balance sheet by as much as $95 billion a month. The risk is that the Fed’s response to inflation pushes the economy into recession.

With the rise of inflation and uncertainty, security selection and diversification are key in investment decisions. Investors have typically turned to quality equities, short duration fixed income and alternative investments such as real estate and private credit for some clients to protect against inflation and diversification and increased emergency reserves to protect against uncertainty.

Over the long term, high quality companies with pricing power have protected against inflation since they are able to raise prices in response to rising costs and are less vulnerable to the rising cost of equity and debt to fund operations. The pandemic and war may be a catalyst to increase innovation in productivity solutions such as automation and software, healthcare, cyber security and energy security. Businesses will likely invest in those areas to improve productivity in a tight labor market. That is, we see opportunity in companies benefiting from those themes and showing rising profitability as compared to those without positive earnings or cash flow.

Source: Cornerstone Macro March 30, 2022

In contrast, companies with low or no near term earnings are vulnerable to multiple contraction in a rising rate environment. Many of the IPOs and SPACs in recent years have yet to demonstrate profitability and other speculative investments such as crypto currencies that offer no prospect of earnings are likely to be volatile. Multiples such as the cyclically adjusted price to earnings ratio are still well above the long-term average of 17.3x.

Source: Robert Shiller

As the Fed raises rates we have a positive view on floating rate loans and other shorter duration credits. Avoiding longer-term bonds should help mitigate losses if interest rates keep rising. It is important to remind investors that reinvestment risk is more important than mark-to-market volatility for long-term bond investors. As bonds mature investors can now take advantage of reinvesting at higher rates. Essential service municipal bonds look attractive now as a big move up in rates over the last few weeks brought muni yield ratios to treasuries to 92% for the 10 year AAA and 104% for 30 year AAA, as of March 31, 2022 according to Nuveen.

With so many moving pieces, we want to emphasize planning, saving, and investing for the long-term. Sticking to a plan, saving and investing on a regular schedule is important as we expect lower real returns in the next few years. If possible, increase savings on a steady automated basis. In times of elevated market volatility or negative press, investors may be tempted to sell and wait for conditions or valuations to improve but attempting to time the market more often results in lost opportunity.

Please listen to our Plutonomix podcasts on the audio provider of your choice, where we discuss investment basics.

Laurie Kamhi, CIO Partner lkamhi@hightoweradvisors.com 917-580-6031

Christine Torrey, Executive Director Ctorrey@hightoweradvisors.com 917-580-6032

Ben Johnston, Director, bjohnston@hightoweradvisors.com 917-580-6033

Raymond Balroop, Senior Client Manager rbalroop@hightoweradvisors.com 917-580-6034

Kendall Duncan, Associate Client Services kduncan@hightoweradvisors.com 917-580-6046

And Welcome…

Brendan Henry, Associate Wealth Advisor bhenry@hightoweradvisors.com 917-580-6038

Coming soon…
We will be hosting our third conference in our market outlooks series this spring with Stephanie Link, Hightower’s Chief Investment Officer. Invitation to follow.

LCK Wealth Management is a team of investment professionals registered with Hightower Securities, LLC, member FINRA and SIPC & Hightower Advisors, LLC a registered investment advisor with the SEC. All securities are offered through Hightower Securities, LLC and advisory services are offered through Hightower Advisors, LLC. This is not an offer to buy or sell securities. No investment process is free of risk and there is no guarantee that the investment process described herein will be profitable. Investors may lose all of their investments. Past performance is not indicative of current or future performance and is not a guarantee. In preparing these materials, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public and internal sources. Hightower shall not in any way be liable for claims and make no expressed or implied representations or warranties as to their accuracy or completeness or for statements or errors contained in or omissions from them. This document was created for informational purposes only; the opinions expressed are solely those of the author, and do not represent those of Hightower Advisors, LLC or any of its affiliates. Third-party links and references are provided solely to share social, cultural and educational information. Any reference in this post to any person, or organization, or activities, products, or services related to such person or organization, or any linkages from this post to the web site of another party, do not constitute or imply the endorsement, recommendation, or favoring of LCK Wealth Management or Hightower Advisors, LLC, or any of its affiliates, employees or contractors acting on its behalf.  Hightower Advisors, LLC, does not guarantee the accuracy or safety of any linked site. Hightower Advisors do not provide tax or legal advice. This material was not intended or written to be used or presented to any entity as tax advice or tax information. Tax laws vary based on the client’s individual circumstances and can change at any time without notice. Clients are urged to consult their tax or legal advisor for related questions.