Notes From Last Week:

It has obviously been a challenging and uncertain year so far for investors.  The S&P 500 Index is down -13.08% year-to-date, which is the worst start to a year since 19391.  The tech-heavy NASDAQ Index is down -22.19%, the worst start to a year in its history1.  Bonds have offered little refuge as the Bloomberg Aggregate Bond Index is down -10.51%, that also represents its worst start to a year since its inception in 1970s1.  In our view, there is one word we’ve been discussing at length in our commentaries over the last 18 months that is the main culprit for this challenging start to 2022:  Inflation.

The combined effects of the pandemic severely constraining global supply chains, geopolitical issues leading to commodity price shocks, and years of excessive fiscal and monetary policies globally has induced inflation levels not seen since the early 1980s1.  Stubbornly high inflation is now forcing central banks globally to raise interest rates substantially.  The Federal Reserve (Fed) and the U.S. central bank raised interest rates 0.50% last week for example. That is a jump rarely seen in the last several decades.  The Fed also suggested there will likely be several more 0.50% rate hikes over the coming months as well.

High levels of inflation and higher interest rates impact the prices of almost everything we consume and invest in.  We have all felt the pain associated with substantial price increases in gasoline and groceries as two examples.  Likewise, many companies are feeling the pain of severe shortages and steep price increases of needed inputs to production.  Higher interest rates induce more price increases as well. For example, home prices up around 20% on average across the U.S. over the last year, are now even more unaffordable. The 30-year fixed rate mortgage rates have jumped from 3% at the start of the year to north of 5.25% now1.  Likewise, companies are now having to pay higher interest rates to finance operations as well.  For instance, Home Depot issued a 10-year bond in September 2021 with an interest rate (coupon) of 1.875%1.  They issued the same type10-year bond in April 2022, but the interest rate required had risen to 3.25%1

Naturally, with the prices of real economy goods and services increasing at such rates, it must also impact the prices of financial instruments.  Companies face higher costs of production and financing at a time when the Federal Reserve is trying to slow the economy, thereby slowing top line revenue growth potential.  That means net earnings potential slows as well.  As investors, we are primarily concerned with the earnings and cash flow generation power of companies, so when this is called into question prices get volatile and typically fall until there is more clarity.  Similarly, bond investors are concerned with the ability of a company to be able to make good on its commitments to pay stated coupon payments and return of principal at bond maturity.  If companies are getting squeezed by higher costs and slowing revenue growth, there are fewer earnings and cash to make their way to investors.  That typically leads to volatility and falling prices in the shorter run. 

It therefore makes sense markets have had one of the most challenging starts to a year in decades, given that inflation is higher than it’s been since the early 1980s.  It also makes sense that the Federal Reserve must raise interest rates to slow the economy enough to better balance aggregate demand and supply to cool inflation. 

The GOOD NEWS is that we think we may already be seeing some cooling in inflation.  For example, the Prices Paid Index of the ISM Purchasing Managers Index came down from 87.1 points in March to 84.6 in April, indicating that big manufacturing businesses may now be facing less input pricing pressures1.  Additionally, the U.S. Oil Rig Count has increased around 10% since Russia invaded Ukraine, which should begin to help bring oil supplies more in to balance after the Russia shock to better meet demand1

Still, labor markets are very tight in the U.S, as evidenced by data from last week.  There are about 11.5 million open jobs and less than 6 million unemployed, for example1.  Friday’s jobs report also showed one of the lowest unemployment rates (3.6%) in the last 50 years1.  Meanwhile, aggregate labor productivity sank the most since 1947 in Q1, while unit labor costs increased at 7.2% year over year, the most since 19821.  Given this evidence, we should expect the Federal Reserve to continue to battle inflation by raising interest rates and selling bonds on its balance sheet, which will likely continue to create financial market volatility.

We think this is an environment that requires immense levels of patience, balance, and discipline from investors.  We do not know exactly when inflation or volatility will subside, so we want to focus on what we can control.  We are longer-term investors, not day traders.  Here are measures we think investors should consider now:

  • Look for opportunities to tax loss harvest while simultaneously increasing the quality of holdings.
  • Rebalance.
  • 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 be really near that target).  Do not try to time the 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 find high quality bonds that offer attractive yields now.
  • Diversify any concentrated positions.
  • Review your financial plan-unless something has changed with your liquidity needs, time horizon or general financial situation, we do not think you should 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 time of volatility. 

Asset Management Department

Sequoia Financial Group


Sources: 1. Bloomberg/Bloomberg News, 2. FactSet, 3 Ned Davis Research, 4 Morningstar Direct

The views expressed represent the opinion of Sequoia Financial Group. The views are subject to change and are not intended as a forecast or guarantee of future results. This material is for informational purposes only. It does not constitute investment advice and is not intended as an endorsement of any specific investment. Stated information is derived from proprietary and nonproprietary sources that have not been independently verified for accuracy or completeness. While Sequoia believes the information to be accurate and reliable, we do not claim or have responsibility for its completeness, accuracy, or reliability. Statements of future expectations, estimates, projections, and other forward-looking statements are based on available information and Sequoia’s view as of the time of these statements. Accordingly, such statements are inherently speculative as they are based on assumptions that may involve known and unknown risks and uncertainties. Actual results, performance or events may differ materially from those expressed or implied in such statements. Investing in equity securities involves risks, including the potential loss of principal. While equities may offer the potential for greater long-term growth than most debt securities, they generally have higher volatility. Past performance is not an indication of future results. Investment advisory services offered through Sequoia Financial Advisors, LLC, an SEC Registered Investment Advisor. Registration as an investment advisor does not imply a certain level of skill or training.

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Investment advisory services offered through Sequoia Financial Advisors, LLC, an SEC Registered Investment Advisor. Registration as an investment advisor does not imply a certain level of skill or training.

Weekly Market Notes 5.9.2022 | Sequoia Financial Group


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