2022 offered a rough start for financial markets. You can’t win ’em all I suppose. There weren’t many places to hide over the past three months, as most asset classes were down by around 5%. So much for diversification! (kidding)
Fortunately, it could have been worse. Stocks were down over 12% in mid-March, before posting a strong performance over the past two weeks. The War in Ukraine introduced a significant amount of volatility and uncertainty into the markets. Many Western intelligence experts and markets overall were surprised by the turn of events in Ukraine. If you owned any Russian stocks, then you’re not a happy camper.
As I wrote last quarter, returns over the past 10+ years have been tremendous. Unfortunately, trees *still* don’t grow to the sky, so it’s imperative to stay rational about the probabilities for future returns and build in a margin of safety to your financial plan. For many people this will mean saving more, working longer, and staying flexible in order to reach financial goals.
During times like these, keeping a long-term focus is paramount. On any given day, it can feel like all the news is bad and hope is in short supply. However, things often have a way of sorting themselves out over time.
Inflation and the Federal Reserve
The Fed has tough job ahead. Headline inflation continued to rise in February, reaching almost 8%. For reference, 8% inflation will cut the purchasing power of cash in half in about 9 years.
The Fed raised short-term rates by 0.25% in March (the first increase since 2018). Interest rates rose sharply across all maturities as the markets began to price in the new reality. Fortunately, bond investors can derive some comfort from higher yields on any reinvested coupon payments. Unfortunately, if you are in the market for a house, then higher mortgage rates are not a happy development. As we move forward, keep an eye out for any inversion in the yield curve (i.e. near term rates above long term rates) as they can often indicate a higher probability of recession.
Recent jobs data has been solid, so the Fed will find some support there. The unemployment rate reached 3.6% in March. A hot labor market combined with an urgent need to bring down inflation will bolster forecasts for significant interest rate increases over the remainder of 2022.
The Fed’s balance sheet offers a significant challenge. Since the onset of COVID, the Fed has added almost $5 trillion of assets to its balance sheet in an effort to support financial markets. These assets primarily consist of US Treasury bonds and mortgage bonds.
Reducing or “normalizing” the size of the Fed’s balance sheet presents a headwind to asset returns in the near term. Leaders at the Fed have indicated that it could take 3 years to complete the process. It’s unlikely that the Fed will sell bonds, but rather let bonds mature in normal course. If the Fed can engineer a “soft landing” for the economy, that’s a great result. However, it’s possible that the Fed will trigger a recession as they go through this process while also raising interest rates.
Economic Growth
The economy continues to hum along in the face of Fed policy changes. Combined with the strong job numbers mentioned earlier, per capita GDP remains strong. Employers seem to be having an easier time finding workers through a combination of increased wages and benefits and dwindling pandemic aid from the government.
Consumer spending remains healthy overall with real PCE growth around 6.9%, but it’s possible that much of this is carryover of pent-up demand from COVID years.
Speaking of COVID, China’s policy of zero-COVID has continued to impair global supply/demand dynamics. Ongoing, large scale lockdowns have pressured manufacturing and logistics as well as Chinese consumer demand. Unfortunately, COVID will continue to hinder economic progress for the foreseeable future.
Corporate profits
Corporate profits hit a new record in the 4th quarter of 2021, albeit with less overall growth. Having done well so far, it will be interesting to see how companies handle changing interest rate and inflation dynamics over the next few years.
Retirement Planning Update
As I mentioned in last quarter’s market commentary, Congress continues to make progress on updating retirement planning policy. The House of Representatives recently passed a updated version of the Secure Act 2.0 legislation, which contains many of the same provisions that were previously discussed:
- Expand automatic enrollment of workers in qualified retirement plans and enable automatic increases in employee contribution amounts.
- Raise the starting age for required minimum distributions (RMDs) from the current age of 72 to 73 starting in 2023. And follow on increases to age 74 in 2030 and age 75 in 2033.
- Reduce the penalty for failing to take an RMD from 50% to 25%.
- Increase the limits on “catch up” qualified retirement plan contributions for workers ages 62 – 64 to $10,000 (indexed for inflation).
- Index the “catch up” contribution limit for IRAs to inflation.
- Allow employers to use an employee’s student loan payments as the basis for matching contributions to the employee’s qualified retirement plan account.
- A new federal database to help people find old 401(k) accounts.
There is a lot of optimism that this legislation will be approved by the Senate and enacted into law.
Market Commentary 1Q 2022
2022 offered a rough start for financial markets. You can’t win ’em all I suppose. There weren’t many places to hide over the past three months, as most asset classes were down by around 5%. So much for diversification! (kidding)
Fortunately, it could have been worse. Stocks were down over 12% in mid-March, before posting a strong performance over the past two weeks. The War in Ukraine introduced a significant amount of volatility and uncertainty into the markets. Many Western intelligence experts and markets overall were surprised by the turn of events in Ukraine. If you owned any Russian stocks, then you’re not a happy camper.
As I wrote last quarter, returns over the past 10+ years have been tremendous. Unfortunately, trees *still* don’t grow to the sky, so it’s imperative to stay rational about the probabilities for future returns and build in a margin of safety to your financial plan. For many people this will mean saving more, working longer, and staying flexible in order to reach financial goals.
During times like these, keeping a long-term focus is paramount. On any given day, it can feel like all the news is bad and hope is in short supply. However, things often have a way of sorting themselves out over time.
Inflation and the Federal Reserve
The Fed has tough job ahead. Headline inflation continued to rise in February, reaching almost 8%. For reference, 8% inflation will cut the purchasing power of cash in half in about 9 years.
The Fed raised short-term rates by 0.25% in March (the first increase since 2018). Interest rates rose sharply across all maturities as the markets began to price in the new reality. Fortunately, bond investors can derive some comfort from higher yields on any reinvested coupon payments. Unfortunately, if you are in the market for a house, then higher mortgage rates are not a happy development. As we move forward, keep an eye out for any inversion in the yield curve (i.e. near term rates above long term rates) as they can often indicate a higher probability of recession.
Recent jobs data has been solid, so the Fed will find some support there. The unemployment rate reached 3.6% in March. A hot labor market combined with an urgent need to bring down inflation will bolster forecasts for significant interest rate increases over the remainder of 2022.
The Fed’s balance sheet offers a significant challenge. Since the onset of COVID, the Fed has added almost $5 trillion of assets to its balance sheet in an effort to support financial markets. These assets primarily consist of US Treasury bonds and mortgage bonds.
Reducing or “normalizing” the size of the Fed’s balance sheet presents a headwind to asset returns in the near term. Leaders at the Fed have indicated that it could take 3 years to complete the process. It’s unlikely that the Fed will sell bonds, but rather let bonds mature in normal course. If the Fed can engineer a “soft landing” for the economy, that’s a great result. However, it’s possible that the Fed will trigger a recession as they go through this process while also raising interest rates.
Economic Growth
The economy continues to hum along in the face of Fed policy changes. Combined with the strong job numbers mentioned earlier, per capita GDP remains strong. Employers seem to be having an easier time finding workers through a combination of increased wages and benefits and dwindling pandemic aid from the government.
Consumer spending remains healthy overall with real PCE growth around 6.9%, but it’s possible that much of this is carryover of pent-up demand from COVID years.
Speaking of COVID, China’s policy of zero-COVID has continued to impair global supply/demand dynamics. Ongoing, large scale lockdowns have pressured manufacturing and logistics as well as Chinese consumer demand. Unfortunately, COVID will continue to hinder economic progress for the foreseeable future.
Corporate profits
Corporate profits hit a new record in the 4th quarter of 2021, albeit with less overall growth. Having done well so far, it will be interesting to see how companies handle changing interest rate and inflation dynamics over the next few years.
Retirement Planning Update
As I mentioned in last quarter’s market commentary, Congress continues to make progress on updating retirement planning policy. The House of Representatives recently passed a updated version of the Secure Act 2.0 legislation, which contains many of the same provisions that were previously discussed:
There is a lot of optimism that this legislation will be approved by the Senate and enacted into law.
Matthew P. Jenkins, CFA, CFP®
Matthew Jenkins is the Founder of Noble Hill Planning LLC. Matthew has over 15 years of experience working in both large and small financial services firms. Before starting his career in finance, Matthew served as a U.S. Army Ranger. Matthew values transparency and fair dealing and enjoys helping people prepare for a great retirement.
Matthew is a CFA® Charterholder and CERTIFIED FINANCIAL PLANNER™ Professional. He is also a member of the National Association of Personal Financial Advisors (NAPFA) and the Fee Only Network.