Stephen M. Mills, CIMA® Partner
Chief Investment Strategist
Brad Bays, CIMA® Partner
PIM Portfolio Manager
Highlights:
- Stocks suffered the first 10% correction since September 2020, as measured by the S&P 500 Index.1
- The U.S. economy remains resilient despite near-term headwinds, in our view.
- The U.S. Federal Reserve has indicated it will be shifting monetary policy to gradual tightening beginning in March.
- Inflation continues to be persistently high, however there are signs it could begin to abate in the latter half of 2022.
- Russia-Ukraine crisis poses a potential near-term threat to the equity markets.
Commentary
Global stock markets have been in correction mode since the first part of the year as investors react to the potential for rising interest rates, higher-than-normal inflation and the Russia-Ukraine crisis, in our view. Coming into the new year, we felt the U.S. stock market was vulnerable to a correction of as much as 10-15% during 2022 due to a number of risk factors which we pointed out in our TCM 2022 Market Outlook & Strategy letter sent out early January.2 Unfortunately, it didn’t take very long for that correction to occur. In January, the S&P 500 Index fell sharply from its all-time high recorded on January 4, reaching the 10% correction threshold on January 28 where it bottomed out with a total decline of 10.9%.1 The Dow Jones Industrial Average faired a little better falling 8.5% over the same period however, the technology laden Nasdaq average slid 15% during that timeframe.1 Growth stocks took the brunt of the selling while value stocks held up better.
We were not surprised by the January correction in the stock market given the run-up in stock prices at the end of 2021 and the near-term challenges we discussed in our January letter. As to the date of this letter, the major averages rallied from the January 28 lows but may be in the process of retesting those levels. We would not be surprised to see this volatility continue over the next few months as investors digest the potential for several interest rate hikes by the U.S. Federal Reserve (Fed) over the course of the year as well as continued high inflation data.
We believe some of the recent market volatility can be attributed to the Russian-Ukraine situation which has escalated over the past several weeks as Russia continues to build up a military presence along their border with Ukraine threatening to invade. We believe if Russia launches an attack on Ukraine, we could see a significant sell-off in the stock market, perhaps in the 3-6% range if history is any guide. According to an analysis done by CFRA, an independent investment research provider, where CFRA analyzed 24 geopolitical events since World War II, CFRA found the S&P 500 Index fell an average of 5.5% from peak to trough coincident with those events.3 The S&P took an average of 24 days from the start of the event to reach a bottom, but it recouped those losses in an average of 28 days later, according to the study.3
The Russia-Ukraine crisis appears to be impacting the oil market as well. Oil prices, as measured by West Texas Intermediate oil (WTI) surged to over $90 per barrel as the crisis escalated recently.1 Goldman Sachs, Morgan Stanley and Wells Fargo Investment Institute11 now forecast summer 2022 oil prices in the $100+ range, citing increasingly tight balances and the need for prices to rise to blunt demand growth.4 In our January letter, we had suggested WTI could hit $100 per barrel which at the time was trading in the mid-70s.2 $100 oil now looks increasingly likely with demand for oil rising as the global economy continues to recover from the coronavirus pandemic.
Another reason for the weakness in stocks is the concern about inflation and how the Federal Reserve is going to respond to the highest inflation numbers since the 1980s. In a report released by the U.S. Labor Department on January 12, 2022, the Consumer Price Index rose 7% for 2021.5 It was the largest 12-month increase in the CPI since June 1982.5 We feel this inflation number stoked fears of more aggressive Fed action to hike interest rates in order to combat rising prices and bring inflation back in line with the Feds’ 2% mandate. We believe these fears led to broad based selling of stocks, especially high price-to-earnings growth stocks that typically underperform in higher interest rate environments from our experience.
Based on comments made by Fed Chairman Jerome Powell on January 26 after a Federal Open Markets Committee meeting, it appears the Fed has opened up its’ inflation fighting playbook which will likely include raising the fed fund rates several times this year along with reversing the Quantitative Easing (QE) measures the Fed put in place at the beginning of the pandemic in early 2020.6 We feel the combination of aggressive Fed action to lower interest rates and inject monetary stimulus into the financial system during the pandemic, along with U.S. government spending, exacerbated U.S. inflation.
We see the Federal Reserve raising the fed funds rate at least 4 to 5 times this year which would place the fed funds rate at .75% to 1.25% by year end. However, if inflation remains on its current pace for the next few months, we may see the Fed bumping rates even higher this year. Some analysts are predicting as many as 6 or 7 Fed rate hikes this year.7 These rate hikes could potentially push interest rates higher on various types of consumer and business loans and possibly lead to a slowdown in spending for goods and services, in our view.
We believe this Fed tightening, along with a reduction of government stimulus spending, will be a headwind for economic growth in the short-term and could cause continued near-term volatility for the financial markets. However, we feel that the economy can handle the Fed rate hikes this year without a significant slowing of economic growth. We see the potential Fed tightening over the next 12-18 months as only returning monetary policy back to pre-pandemic levels which we believe was still very beneficial for the economy and financial markets.
Despite the near-term headwinds from the change in Fed policy, we see strong fundamental support for the economy from both businesses and consumers. Consumer spending accounts for two-thirds of our nations GDP. The January U.S. retail sales report showed consumer spending rose 3.8%, according to the U.S. Department of Commerce February 16 report, marking the strongest monthly gain since last March.8 We believe this is a good indication that the U.S. economy is healthy and poised to deliver strong growth in 2022. In addition, the February 18, 2022 LEI report, (Leading Economic Indicators) released by the Conference Board for January, continues to indicate future economic growth for this year.9 The Conference Board estimates that U.S. GDP (Gross Domestic Product) growth would slow for the first quarter of 2022 but expand by 3.5% year-over-year for 2022.9
In summary, despite the current challenges and near-term volatility of the financial markets, we remain positive on both the U.S. economy and stock market for the remainder of 2022. We believe the correction in U.S. equities will run its course soon and the bull market, that we believe began in March 2020, will resume its upward trend. One option is to use the current prices correction to put idle cash to work where appropriate. Cash is still earning next to nothing and with inflation running at over 7% annually, funds in cash holdings are losing purchasing power. Based on one’s investment objectives, using cash to selectively add to risk assets may make sense in the current environment.
As always, we greatly appreciate your continued trust and confidence in us and we will continue to work to keep you informed of economic and market developments.
Your Trinity Capital Management Team
Trinity Capital Management, 821 ESE Loop 323, Suite 100, Tyler, Texas 75701. 903-747-3960. www.tcmtx.com
Footnotes
- Thompson Charts
- TCM 2022 Market Outlook & Strategy letter, January 10, 2022
- Reuters.com - “As Markets Churn Over Russia-Ukraine Conflict, History Shows Fleeting Impact.” February 14, 2022
- Seeking Alpha “Is $100+ Oil Dependent On Conflict Between Ukraine and Russia.” February 15, 2022
- CNBC.com, “Inflation Rises 7% Over the Past Year, Highest Since 1982” January 12, 2022
- CNBC.com, “A Full Recap of the Fed Rate Decision and the Powell Remarks That Knocked the Stock Market,” January 26, 2022
- CNBC.com, “Why the Fed might not go through with 6 or 7 priced-in interest rate hikes” February 16, 2022
- The Wall Street Journal, “U.S. Retail Sales Show Consumer Appetite for Spending Amid High Inflation” February 16, 2022
- The Conference Board, February 18, 2022.
- Reuters.com, “U.S. Leading Economic Indicator Rises Strongly in December,” January 21, 2022.
- Wells Fargo Investment Institute, Inc. is a registered investment adviser and wholly-owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company
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S&P 500 Index:The S&P 500 Index consists of 500 stocks chosen for market size, liquidity, and industry group representation. It is a market value weighted index with each stock's weight in the Index proportionate to its market value.
Dow Jones Industrial Average: The Dow Jones Industrial Average is a price-weighted index of 30 "blue-chip" industrial U.S. stocks.
Past performance is no guarantee of future results and there is no guarantee that any forward-looking statements made in this communication will be attained.
NASDAQ Composite Index: The NASDAQ Composite Index measures the market value of all domestic and foreign common stocks, representing a wide array of more than 5,000 companies, listed on the NASDAQ Stock Market.
The Consumer Price Index(CPI) is a measure of the cost of goods purchased by average U.S. household. It is calculated by the U.S. government's Bureau of Labor Statistics.
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