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First Quarter Roundup: Interest Rate Hikes, Ukraine/Russia Crisis, Inflation

Published 04/03/2022, 12:59 AM
Updated 07/09/2023, 06:31 AM

Index/Asset March 2022 1st Quarter 2022

Y H &C Results Are not GIPS Certified and dependent on third party calculations. They are time weighted

U.S. Economic And Financial Markets Outlook-Inflation Pushes Fed on Rates as Putin Invades Ukraine, Markets Sell Off! (Return figures in this section come from the Feb. 28, 2022, editions of the Wall St. Journal. Y H & C Investments may have positions in companies mentioned in this newsletter. It is the responsibility of each investor to research investments mentioned so they can decide on the appropriateness and suitability of the investments consistent with their risk tolerance, risk constraints, and return objectives.)

In March, the Dow Jones Industrial Average gained 2.61%, the S&P 500 increased 3.83%, and the NASDAQ rose 5.04%. The first quarter was a tough one for the three major indexes as the Dow lost 4.72%, the S&P 500 fell 5.20%, and the technology heavy NASDAQ dropped 9.6%.

The first quarter of 2022 is a prime example of how quickly the environment can change in financial markets. Heading into the year, the financial community was occupied with how quickly Chairman Jerome Powell and the Federal Reserve would raise interest rates to try and get a handle on the rapid rise of inflation in the back half of 2021.

Suddenly acknowledging price increases were not temporary in the final quarter of last year, the Fed is now seen as behind the curve and needing to become much more aggressive in fighting inflation. Some analysts see multiple fifty basis point increases during the balance of the year (one hundred basis points make up 1%).

Investors sold off anything with distant promises of profitability, or with excess valuation. Technology entities, centered in the NASDAQ, were hardest hit. World events interfered when Vladimir Putin decided to enter Ukraine in a militaristic manner designed to change the Eastern European territorial landscape.

Investors realized the dramatic impact on the entire commodity complex (especially energy, wheat, corn, nickel, and palladium). The western world reacted in a surprisingly unified way with a whole slew of economic restrictions.

Many of the largest companies in the world have left Russia, suspended operations, or announced divestments of subsidiaries in large Russian based enterprises with financial ties to Putin’s Kremlin.

Mr. Powell recently raised rates twenty-five basis points, which is less aggressive than most analysts forecasted. His public statements indicate the ramifications of the Ukraine conflict are part of the Fed analysis. In doing so, Powell and the crew have seen energy prices soar, with oil reaching $120 per barrel. The effect on all areas of the supply chain is being felt by consumers and businesses across the globe.

Economists are watching the always important yield curve (Treasury bonds) and noticing the flattening. The worry was the yield curve would invert—which it did last week. Inversion is when short term rates are higher than longer durations (2y> 10 yr.). Historically, an inverted yield curve is a strong predictor of a recession.

For investors in the capital markets, global events are just part of navigating a constantly changing environment. Admittedly, with COVID still lingering, inflation at 28 year highs, and a war affecting supplies for global commodities, the current climate is loaded with serious issues.

Still, equity markets revolve around profits. All the concerns can and will affect company performance, but maybe not as much as some believe, or the market has already priced in. It is long known markets climb a wall of worry, and investors certainly have plenty to worry about, don’t we?

Global Economic And Financial Markets Outlook- Russia’s Invasion of Ukraine Casts Pall on Global Markets! (All country index data provided by countryeconomy.com, Mar. 31, 2021.)

It has long been known in the investment world that military conflict is not good for economies, businesses, or stocks. If one considers the phrase, 'Peace Dividend,' global investors have long benefited from a conflict free world for two decades, especially in North America and Europe. When Vladimir Putin decided to invade Ukraine in late February, all of Europe and especially its Eastern European countries, came to a swift realization Russia could no longer be seen as an acceptable member of the global economic community.

Investors quickly realized the gravity of the situation and ever since then, there exists an uneasiness in global markets. The dramatic NATO sanctions on Russia, along with the billions of frozen Russian assets, only escalates an already difficult conflict.

Moreover, turning Russia into a pariah state places significant pressure on the rest of Europe and Asia for finding supplies of energy and food. Historically, Putin’s endeavors are long drawn-out affairs and there is little evidence to suggest the Ukraine campaign will be a short one.

As a result, investors should come to recognize $100 per barrel oil and higher inflation all along the supply chain will be around for quite some time. We are seeing plenty of opinions telling of a dramatic slowdown in European economies, and some investment banks are already proclaiming Europe in a recession.

Looking at global financial markets, the common pattern over the last month is Eastern European and Nordic country indexes selling off on guilt by association. Interestingly, Brazil shows nice returns as the largest economy in South America is well removed from Ukraine situation. Of note is Brazil’s central bank lifting interest rates to 10.75% to fight inflation. It has also announced it will slow the rate of hikes to let the economy digest the eight prior increases from that bank’s previous policy moves. Do you think Jerome is paying attention to Brazil?

The Art of Contrarian Thinking-You Can Focus on Macro, But You Are Better Off Concentrating on Specific Companies! (YH & C Investments may have positions in companies mentioned herein. It is the responsibility of each investor to research investments mentioned so they can decide on the appropriateness and suitability of the investments consistent with their risk tolerance, risk constraints, and return objectives.)

Over the last three months, investors have seen the Mr. Hyde nature of the stock market. For a variety of reasons, many stocks have lost a great deal of value, let’s call it over 20%. More dramatic, companies people believed would be excellent assets to own for an extended period because of their strong technology and leadership positions have been thumped even worse.

Many have seen huge reversals of investor sentiment with the stocks down 50, 60, and 70% or more. Equity markets are notoriously fickle, and informed investors evaluate many aspects of the capital markets to help them understand how to manage the volatility.

Much of the analysis is macroeconomically related. Equity values are always going to be related to interest rates. Interest rates and their differentials are tied to inflation, employment, and growth. Currencies move interdependently with each one of these variables. Consequently, investors gather as much information about these statistics to create more of an understanding of what the future might bring.

Yet, with all this data, the best strategy is to focus on a few companies and their business results. Yes, stock prices are going to be tied to market and industry movement. However, if you are correct about a company and its execution, you have a good chance of being rewarded.

Many stocks outperform in difficult markets. If your analysis is correct, the market will eventually reward you even in down periods. The last three months have been tough, and the next few quarters might be even more difficult. Focus on being right and you will navigate potential storms just fine.

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