By: Stash Graham
February continued January’s weakness as all three major domestic indices were down on conflict concerns in Ukraine. The benchmark S&P 500 fell a second straight month and was down -3.1%. The Dow Jones Industrial Average was down -3.5%, while the technology sector heavy NASDAQ Composite Index was down -3.4%. The Nasdaq Composite is down more than -12% to start the year. The S&P 500 has fallen over -8% and the Dow Jones Industrial Average is down -6.7% during the first two months of 2022. Our gold tracking position (Ticker: IAU) was up +2.36% for the month and +3.3% for the year. We are very pleased with our outperformance to start the year.
The weakness in February started quickly as the markets continued to increase the expectations of monetary policy tightening by the Federal Reserve. As the increase in rate expectations came, earnings multiples fell broadly. Companies that traded at high valuations fell materially. More modestly valued companies fell less. Still, broadly markets pared risk as market participants repriced asset prices. In addition, the Russia/Ukraine war was introduced in the second half of the month and further exacerbated downside pressure. Towards the very end of the month, the stock market rebounded slightly as the developments in Eastern Europe caused a repricing in the odds of whether the Federal Reserve would increase interest rates as quickly as first thought. The market is betting that we only see a 25 basis point hike instead of the previously thought 50 basis point increase. High-duration stock prices benefited from this development as the central bank mentioned the Russian invasion as an “uncertainty.”
A higher floor on inflation is expected due to a surge in energy costs resulting from the Russian invasion of Ukraine. Economists formerly expected inflation to subside materially come the Spring months. Year-over-year inflation prints will still come down from the 8-9% levels where they currently reside; however, with barrels of oil priced over $100 for the first time in five years, the speed at which inflation falls should be slower than first anticipated. Inflation has been the primary concern of the Federal Reserve since the Federal Reverse Chairman’s pivot in early November, and the problem is getting worse due to the Russian invasion. Yet because the stock market has corrected (Nasdaq in a bear market), market participants perceive that the Federal Reserve might be more dovish (slower with interest rates hikes) to prevent further market stock selling pressure. The slower hike pattern may happen, but the Federal Reserve risks higher inflationary pressures later into the year. As you can see, the Fed finds itself in an incredibly tough situation where inflation is starting to put the economic growth levels under material pressure. Yet, the Federal Reserve is struggling to act due to foreign events.
Last week, market participants received the consumer spending report for January, and the headline figure would indicate that everything was ok and people were spending with great confidence. Sadly when accounting for the changes in inflation levels, readers learned that consumer spending declined on a year over year basis. Consumers are concerned about higher sticker prices, and their wages are not keeping up with inflation. Richard Curtin, the person behind the widely followed University of Michigan Consumer Sentiment Survey, “26% (of survey participants) in February expected their finances to worsen, the highest since May 1980… the median expected annual increase in household income was 1.9% in February, far lower than the anticipated year-ahead inflation rate of 4.9%.” A couple of times in 2021, we wrote about the growing risks of a stagflationary environment. By the late Spring/early Summer, we estimate that the United States will try to navigate stagflation. However, without the sugar highs of fiscal support, economic growth can not sustain growth levels above inflation. While domestic recession risks remain low, as of right now, economic growth should sit below inflation levels.
We sent out a ‘Market Update’ on February 24th to clients that receive digital communications. This notice laid out what we have done to protect investor capital and how we will invest in this changing environment. If you would like a copy of this correspondence, please feel free to reach out to me or anyone on the team, and we will get you that letter in a timely fashion.
As stock market volatility looks to increase in the coming months, we will look to increase our communications with you! We appreciate the trust you place in us and are very glad to report continued outperformance compared to broad market indices to start the year.
We are very aware of the changing tides in investment markets. In short order, we are looking to invest newly found back into sectors and companies whose structural tailwinds are pronounced compared to the cyclical headwinds that could produce turbulence along the way. The selling pressure should remind what we said in the December letter that the easy returns in the stock market had been made. Therefore, it is more important than ever to be tactical with our investing approach. As always, we appreciate the trust that you give us!
The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon.
All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.
Graham Capital Wealth Management, LLC (“Graham”) is a registered investment advisor. Advisory services are only offered to clients or prospective clients where Graham and its representatives are properly licensed or exempt from licensure.