It's All About Inflation
Director of Investment Strategy
It has been a turbulent 2022 for investors as both stocks and bonds demonstrated a historically weak first half of the year. The challenges facing investors are plentiful as we work our way through the pandemic hangover, which has manifested itself in the form of the worst inflation problem in the U.S. since the 1970’s. There has been a confluence of events leading up to where we have arrived today, much of which has been discussed ad nauseam so far this year (and in our previous communications over market volatility through 2022). With COVID-19 still disrupting global supply chains, further lockdowns in China seem to be inevitable as the so-called COVID Zero policy remains a priority in Beijing. Russia’s devastating raid on Ukraine, arguably the biggest geopolitical threat in Europe since WWII, continues to add pressure to energy costs. All of which contribute to what is, in our opinion, the largest obstacle on the horizon: Inflation. This, in turn, has place a renewed pressure on interest rate policy and has put Jay Powell and the Fed in a seemingly impossible position.
Inflation in and of itself if not a terrible thing, in fact, it is an expected element of a healthy economy. Too much inflation, however, presents unique challenges and is unsustainable; therein lies the problem. June headline inflation roared to 9.1% from one year ago, the largest advance we have seen since 1981. Economist projected inflation would ring in at about 8.8%, marking this the fourth straight month that inflation has outpaced expectations. Not surprisingly, key drivers were the significant increase in energy prices last month and an increase in transportation costs – which is one of the largest input costs to virtually all durable goods that consumers purchase. June gas prices were up 60% from a year ago and 11% month over month. Excluding food and energy, CPI rose 5.9% year-over-year and at a slightly slower clip from May. The Fed is widely expected to raise rates by another 75 basis points later this month, especially since the job market is strong enough to support a front-loading of rate hikes. Even despite rising rates and what feels like runaway inflation, the economy and labor markets have remained strong – almost stubbornly so. Some weaking is expected, and would be admittedly a healthy sign, one that would give the Fed some confidence to slow the pace of hikes in future periods.
The good news, however, is that real time data is showing that the pace of inflation is slowing and there seems to be some respite on the horizon with respect to energy prices. This is something everyone has undoubtedly seen at the pumps lately as prices have fallen nearly a dollar from their peak last month, with a handful of states seeing average prices below $4/gallon for the first time in 90 days. Meaningful changes in economic conditions do not happen overnight, and policymakers need to have confidence that the long-term trends are heading in the right direction before we are out of the woods.
Turbulence cannot be avoided as an investor, but we should not let that stop us from progressing toward our financial goals. Today’s investing climate is challenging at best, but history has proven that patience will be rewarded despite short term drawdowns. As we look forward, we remain confident in the strategies we have presented to keep you on the path of achieving your long-term goals.
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