Wow, where do I start? Perhaps with raging inflation not seen since the early 1980s, partisan government dysfunction or Russia invading Ukraine?  I’m not sure where to start, but the markets seemed to know where to start by heading down as the calendar turned to 2022.  The S&P 500 hit correction territory (down over 10% from recent highs) and the Nasdaq hit bear market territory (down over 20%) as Russia marched into Ukraine. As remarkably fast as those lows were hit were the sharp recoveries off those lows into the end of the quarter. The S&P 500 ended down only 4.95% and the Nasdaq down 8.95%. Given the impressive gains from 2019 through 2021 and the daily bombardment of negative reporting on inflation, interest rates and war, the drawdown ended up being painful, but modest given the circumstances.

The best performing sectors of the market were those related to commodities, especially oil. Oil prices, which headed up most of last year and the early part of 2022 spiked with the Russian invasion of Ukraine as Russia is a huge producer and the European Union’s biggest supplier of both oil and natural gas. Other commodities such as metals and lumber also rose sharply exacerbating inflationary pressures. Together with the tight labor market and rising wages, the commodity input costs served to put inflation and headlines highlighting rising prices in front of both the public and the Federal Reserve Board. The Federal Reserve began to raise its benchmark lending rate in March, the first of what is expected to be a series of interest rate increases throughout 2022 and 2023 to combat inflation, hopefully without leading to a recession.

Prior to the March increase of 0.25%, the benchmark rate had been at or near zero since the start of the pandemic when the Fed was concerned about the slowdown/shutdown of the economy and deflation and waning demand was a bigger concern than inflation. If you recall, oil futures dropped below zero intraday during the early days of the pandemic as traders did not want to absorb the cost of storing all the oil that wasn’t expected to be consumed.  How times have changed. Demand for goods replaced demand for services as people continued to social distance and production of goods was slowed by factory closures and pandemic restrictions. Oil producing countries cut back on production during the pandemic reducing supply and demand returned with economic growth resulting in $100 plus/barrel oil starting in the early days of the Russian invasion.

Value stocks have been outperforming growth stocks so far this year led by the energy sector as the integrated oil companies (think Exxon Mobil and Chevron) have benefited from the increase in oil prices. Utilities, financials and consumer staples, other sectors considered mostly value as opposed to growth, have held up well during the quarter. Some of the green energy investments in solar, wind and electric vehicle supply chain companies, performed in-line with the markets. I expect the move toward energy independence in Europe to reduce reliance on Russian fossil fuel exports to strengthen sanctions will lead to more discussion and hopefully policy adjustments towards greener, domestic sources of energy. These changes towards energy independence will likely be measured in years, not months, so some sanctions that include banning of imported Russian oil and gas may be off the table in the near-term for fear of damage to European economies.

Shares of technology, real estate, and consumer discretionary (non-essential manufacturing and retail) companies performed poorly during the quarter. Real estate and discretionary spending are adversely affected by higher borrowing rates via mortgages and consumer credit. The technology sector is comprised of higher multiple companies that offer the promise of growth meaning that potential profitability is further in the future than value stocks. Higher interest rates increase the discount rate used in valuing future cash flows resulting in lower valuations.

Bond markets had their worst quarter in decades as increasing rates and the prospect of continued rate increases led to higher yields and lower prices as bond prices move inversely to yields. Nobody, including the Federal Reserve Board members know how long inflation will persist or how effective their rate increases will be in dampening inflation since there are both supply and demand issues that have contributed to the rise. Yields on investment grade corporate bonds are the highest they have been since the Fed induced selloff market during the fourth quarter of 2018, so I believe bonds are more attractive than they have been in years.

I hope you are all well and looking forward to springtime. Should you have any questions about the attached report, this email, your portfolio, or anything else related to your financial life, my line is always open.

Best regards,

Steve