Meteorologists are forecasting the first major heat wave of the summer will affect much of the country this week, compounding the discomfort of the other heat wave in which we are already embroiled: persistently torrid inflation. The Consumer Price Index (CPI) for May released last week again surprised strongly to the upside. And, mostly due to this high inflation, consumer sentiment plunged in the latest University of Michigan survey. Both stock and bond prices were down again as a result, anticipating even more constrictive monetary policy from the Fed. Here is our take on last week’s numbers:
- The CPI increased 1% in May, exceeding the consensus forecast of 0.7%. The CPI was up 8.6% year over year, the highest rate since December of 19811. Energy accounted for about one-third of the year-over-year surge, up 34.6%, while food prices soared 10.1%3. That represents the largest year-over-year increase in food prices since May 19811.
- The Core CPI, which strips out volatile food and energy prices, was up 0.6% in May, exceeding the 0.5% Street forecast1. Nearly all components were positive, indicating broad-based inflation1. Shelter prices, a stickier component of inflation and the largest weight in the Core CPI, were up 0.6%, the most since January 19913. Airline fares were up 12.6% in May, while used cars jumped 1.8% and new vehicles increased 1%3.
- The preliminary June University of Michigan Consumer Sentiment survey plunged to a record low of 50.2, well below the consensus forecast of 591. The assessment of current conditions dropped to the lowest level since May 1975, and consumer expectations were the worst since May 19803. Almost half of participants in the survey cited inflation as the reason for their poor sentiment, the second-highest number since 19813.
- Interest rates surged on the inflation news. For example, the yield on the 2-Year Treasury Note surged 0.40% last week alone to 3.06%, the highest level 20071. This surge indicates that market participants expect the Fed to have to raise interest rates and reduce monetary accommodation ever more aggressively to get inflation to recede. This process is likely to continue to create volatility in financial markets.
- The S&P 500 was down 5.04% last week and down -17.60% year to date. The NASDAQ Index was down 5.59% last week and -27.26% so far in 20224. Our global benchmark, the MSCI ACWI IMI, was down 4.43% last week and is down -17.15% year-to date1. The Bloomberg Aggregate Bond Index was down 1.52% last week and -10.65% in 20221.
We again reiterate that this environment requires patience, balance, and discipline from investors. We do not know exactly when the inflation heat wave and related volatility will subside, so we need to focus on factors we can control. As longer-term investors, not day traders, we suggest investors should consider these measures now:
- Look for opportunities to tax loss harvest while simultaneously increasing the quality of holdings.
- Maintain diversification
- Expect continued volatility in 2022.
- Stay near “neutral points” with risk tolerance (i.e., if your risk tolerance indicates a 60% stock/40% bond allocation, then stay very near that target) and do not try to time market moves.
- Seek companies that have strong competitive advantages, excellent management, solid balance sheets and generate free cash flow, which should allow them (and you as an investor) to hedge inflation.
- Seek opportunities for investment-grade yield: since interest rates have moved substantially higher this year, one can now find high-quality bonds that offer attractive yields.
- Diversify any concentrated positions
- Review your financial plan - but unless your liquidity needs, time horizon or general financial situation have changed in some way, we suggest that you not make any large changes to your asset allocation.
- Don’t panic and make rash decisions. Keep calm and carry on - inflation will come down over time, and our economy and markets will be much healthier if we can maintain higher levels of interest rates compared to the last decade or so.
Thank you for your confidence in our team during this period of volatility,
Asset Management Department
Sequoia Financial Group