by Franklin J. Parker, CFA
- Inflation is the hot topic, with producer prices and headline inflation both posting very strong readings last week. This increases the likelihood of the Fed raising rates at their March meeting. Also—and this was a big disappointment—retail sales posted considerably weaker than expected for December calling into question the strength of earnings season. Weak retail sales may also indicate that consumers are beginning to feel inflation’s pinch—a bad omen if they continue.
- Russian rhetoric over Ukraine has grown more intense, claiming that talks have “hit a dead end” all while Poland warns European leaders that the risk of war has gown. While not a direct market concern, threats to geopolitical stability significantly increase the uncertainty that currently hangs over market prices. Russia’s leverage over Europe is, of course, its supply of natural gas. Prices have varied wildly since tensions began, but the strength of that leverage should wane once winter passes.
- From a portfolio perspective, I have grown increasingly pessimistic. Markets have less and less to look forward to, and the Fed’s commentary has grown much more hawkish over recent weeks (especially in light of recent inflation and employment figures). I maintain that this does not look to be the end of the cycle, but I do think the risk of a significant correction in the next month or two has grown. As I have always said, however, how you position your portfolio will be dictated by your goals.
Much of the upward momentum we enjoyed coming out of 2020 has been spent, and markets are now fighting for every upward step. Of course, the main portfolio challenge is that bonds and stocks are struggling together, so the benefits of diversification are significantly lessened.
There are diversifiers, however. In an inflationary environment, energy tends to outperform as do most commodities (especially food-based commodities, like corn, wheat, etc). Bank stocks should benefit from a steeper yield curve, and gold marches to the beat of its own drum, which can be good in a portfolio. I am cautious, however, of other asset classes that have been labeled “alternative.” Real estate, for example, is likely to be negatively influenced by higher rates (just like stocks and bonds), and venture capital/private equity have the same challenges. That is not to say we should not own them, just that the role they play in a portfolio should not be as a diversifier.
I see 2022 as a difficult year for investors. While the back half of the year will probably be better than the first part of the year, I’m not confident we will see the double-digit returns that we have seen for the past few years. For existing clients, I have already been making portfolio adjustments (and will continue to do so). For folks who would like a second opinion on how they are positioned for 2022, we would love to chat with you.
Chart of the Week
Covid has wrought havoc on supply chains, and some price increases are certainly due to that. However, it is very hard to ignore how much the supply of money has increased over the past year. Through 2020, of course, the money supply expanded by 25% year-over-year, which is the largest expansion, by far. However, even if we were to take away that spike, the current money supply expansion would be the largest since 2008 (which was the previous record).
You can think of a dollar as a share of the economy. When the economy is growing each dollar is worth more. When we create more dollars, we subdivide the economy into more pieces, making each dollar worth less. So, there is a tug-of-war: more dollars make each dollar worth a bit less, but a growing economy makes each dollar worth a bit more. Inflation happens when we create dollars faster than the economy grows.
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