A Turbulent First Quarter
Tilt-a-World, Roller Coaster, Bumper Cars, Double Shot. You name the ride and investors have been on it for the past 10 weeks. Inflation, rising interest rates, and geopolitical upheavals in the first quarter of 2022 have created a perfect storm of uncertainty and confusion. The Dow and S&P have seen corrections (10% decline), and the Nasdaq has entered bear territory (20% decline).
When Russia invaded Ukraine, it sent financial shockwaves throughout global markets. Currently, with daily visual updates of the carnage in Ukraine, it is reasonable that the majority of Americans see this war as the greatest threat to our markets and economy. There is no question that the conflict has rattled investors. We believe, however, that inflation, not the war, is the greatest headwind and threat to the markets and the economy.
The Consumer Price Index (CPI) rose to 7.9%, year-over-year. This represents the highest CPI since January, 1982, and a .08% rise over January of this year. Energy was the biggest culprit, rising 3.5% in February. After Russia’s invasion on February 24, crude prices have risen more than 30%. Since this data was collected 10 days ago, inflation is probably now running over 8%.
Gas has been our biggest culprit. The supply-and-demand imbalance that occurred during the pandemic has been exacerbated by Russia’s invasion of Ukraine. Higher consumption of gas, sanctions against Russia, and the never-ending demand for oil could raise the price per barrel to the $150 range. Energy inflation is likely to get worse before it gets better.
We were not shocked or even surprised by the CPI numbers. We have been predicting substantially higher rates since mid-2021. The Federal Reserve pumped money into the American economy through quantitative easing and buying assets. While this avoided a recession, it sowed the seeds of inflation, which we are now reaping.
The Russian-Ukrainian war has amplified inflation. No war is good for inflation. War creates shortages, supply-chain clogs, disruptions of commodities, higher prices, greater demand, and deficit spending. Before the Russian-Ukrainian conflict, we calculated that inflation would be brought down to 3% by the end of the year. This latest Black Swan suggests that inflation my end the year in the 4% – 5% range. We believe seven or eight increases in Fed rates of .25% is highly likely. If inflation continues to resemble the Double Shot, they may wish to accelerate their timetable.
With rising inflation and international conflict, we should not fall off our chairs to find that the University of Michigan Consumer Confidence Index fell to 59.7 in March, the lowest reading since November, 2011.
Predictably, investors may feel that they are riding a Tilt-a-World; investor confidence has been deteriorating during the past three months. We do not recommend adjusting your portfolio based on the current military conflict in Ukraine. We recommend patience. Stock prices change daily, sometimes shockingly so. The quality and fundamentals of the underlying company, however, generally have not changed.
Should investors be worried or fearful because of the roller coaster ride they have been on? The short answer is “No.” Market corrections are not unusual. Since 1946, for instance, the S&P has experienced 29 corrections of 10% – 20%. The average time to recover has been about four months. Ride out the wild rides we have been experiencing. Our feet will be back on terra firma soon.