Inflation, the Fed, Ukraine, Corrections; Oh My!

KEY OBSERVATIONS

• Many markets entered a technical correction (defined as a 10 percent pull back or more) in January as headline inflation reached levels not seen since the 1980s[1] and the Federal Reserve continued to shift its stance, becoming less accommodative.
• It is worth noting the level and pace of the pullback year to date is typical. The median intra-year draw down in the S&P 500 since 1980 is 9.3 percent.[2]
• We continue to monitor the situation in Ukraine. From analyzing historically similar types of geopolitical events, there does not tend to be long term financial market impacts.

Fixed income investors took note of the Federal Reserve’s recent actions. As a result, interest rates moved higher during the month. The U.S. yield curve flattened as the U.S. 10-Year Treasury Yield ended the month at 1.79 percent, 27 basis points higher. Credit spreads widened in January as well, with investment grade and high yield credit spreads gaining 14 and 59 basis points, respectively. The higher move in interest rates, coupled with widening credit spreads, pushed bond prices lower. The broad fixed income market, as measured by the Bloomberg U.S. Aggregate Bond Index, returned -2.2 percent in January – the worst start to a calendar year since 1980.

Inflation

While CPI figures in January were eyebrow-raising and may persist longer than some would prefer we believe they are unsustainable. A combination of cooling in the red-hot energy market, easing shortages of semiconductors and used car prices and unkinking of the global supply chain can help moderate headline figures. Early signs of easing can be seen below in the ISM manufacturing data and the Baltic Dry Shipping Index, which moderated from highs in 2021. With that said, we do not anticipate inflation dropping to the one to two percent range we have seen over the past two decades. We fully anticipate a more robust inflation environment in the coming years at three percent plus and believe portfolios should be positioned accordingly.

The Fed & Interest Rates

The Federal Reserve initiated seven cycles of rate increases since April 1983 and the average return of the Bloomberg U.S. Aggregate Index over those time periods was 3.9 percent. However, the average starting yield to worst (YTW) of the index across those periods was 6.7 percent. As of January 31, 2022, the Bloomberg Barclays Aggregate YTW was 2.1 percent.[6]

This indicates two things:

1. We believe the death of bonds is likely overstated. They can still play a critical role in portfolio diversification to control volatility.
2. Investors should consider their current exposures carefully. Extended interest rate risk, low current yields and less accommodative monetary policies may reveal risks that were previously nascent or perhaps unknown within fixed income.

Concluding Remarks

We will continue to monitor the impact of inflation and decisions by the Fed about raising interest rates. We are also carefully monitoring the situation in Ukraine. From a market perspective, history indicates that these type of geopolitical events do not have long term impacts on the market but certainly could further increase volatility that we have seen this year.

We’d love to hear from you if you have any questions.

[1] WSJ: Where Inflation Rose in 2021 in Seven Charts

[2] Fiducient Advisors – 2022 Outlook – Navigating Moderation

Indices cannot be invested in directly. Index performance is reported gross of fees and expenses and assumes the reinvestment of dividends and capital gains. Past performance does not indicate future performance and there is a possibility of a loss. See disclosure page for indices representing each asset class.

Comparisons to any indices referenced herein are for illustrative purposes only and are not meant to imply that actual returns or volatility will be similar to the indices. Indices cannot be invested in directly. Unmanaged index returns assume reinvestment of any and all distributions and do not reflect our fees or expenses.

• Consumer Price Index is a measure of prices paid by consumers for a market basket of consumer goods and services. The yearly (or monthly) growth rates represent the inflation rate.
• Bloomberg U.S. Aggregate Index covers the U.S. investment grade fixed rate bond market, with index components for government
  and corporate securities, mortgage pass-through securities, and asset-backed securities.
• The S&P 500 is a capitalization-weighted index designed to measure performance of the broad domestic economy through changes in
  the aggregate market value of 500 stocks representing all major industries.
• The NASDAQ is a broad-based capitalization-weighted index of stocks in all three NASDAQ tiers: Global Select, Global Market and
  Capital Market.
• Russell 1000 Growth measures the performance of those Russell 1000 companies with higher P/B ratios and higher forecasted
  growth values.
• Russell 1000 Value measures the performance of those Russell 1000 companies with lower P/B ratios and lower forecasted
  growth values.
• Russell 2000 consists of the 2,000 smallest U.S. companies in the Russell 3000 index.
• Russell 2000 Growth measures the performance of the Russell 2000 companies with higher P/B ratios and higher forecasted
  growth values.
• Russell 2000 Value measures the performance of those Russell 2000 companies with lower P/B ratios and lower forecasted
  growth values.
• MSCI EAFE is an equity index which captures large and mid-cap representation across Developed Markets countries around the world, excluding the U.S. and Canada. The index covers approximately 85% of the free float-adjusted market capitalization in each country.
• MSCI EAFE Value captures large and mid-cap securities exhibiting overall value style characteristics across Developed Markets countries around the world, excluding the U.S. and Canada. The value investment style characteristics for index construction are defined using three variables: book value to price, 12-month forward earnings to price and dividend yield. The index targets 50% coverage of the free float-adjusted market capitalization of the MSCI EAFE Index.
• MSCI EAFE Growth captures large and mid-cap securities exhibiting overall growth style characteristics across Developed Markets countries around the world, excluding the U.S. and Canada. The growth investment style characteristics for index construction are defined using five variables: long-term forward EPS growth rate, short-term forward EPS growth rate, current internal growth rate and long-term historical EPS growth trend and long-term historical sales per share growth trend. The index targets 50% coverage of the free float-adjusted market capitalization of the MSCI EAFE Index.
• MSCI Emerging Markets captures large and mid-cap representation across Emerging Markets countries. The index covers approximately 85% of the free-float adjusted market capitalization in each country.
• MSCI Emerging MarketsValue captures large and mid-cap representation across Emerging Markets countries. The index covers approximately 85% of the free-float adjusted market capitalization in each country. The value investment style characteristics for index construction are defined using three variables: book value to price, 12-month forward earnings to price and dividend yield. The index targets 50% coverage of the free float-adjusted market capitalization of the MSCI Emerging Markets Index.
• MSCI Emerging MarketsGrowth captures large and mid-cap representation across Emerging Markets countries. The index covers approximately 85% of the free-float adjusted market capitalization in each country. The growth investment style characteristics for index construction are defined using five variables: long-term forward EPS growth rate, short-term forward EPS growth rate, current internal growth rate and long-term historical EPS growth trend and long-term historical sales per share growth trend. The index targets 50% coverage of the free float-adjusted market capitalization of the MSCI Emerging Markets Index.
• Institute for Supply Management (ISM) Manufacturing Purchasing Managers’ Index (PMI) is a monthly measure of US economic activity based on surveys from US manufacturing firms; it is a composite index with equal weights to sub-indexes, including new orders, production, employment, supplier delivers and inventories.
• Baltic Dry Shipping Index measures the cost to ship various dry raw materials used in manufacturing, such as coal, iron ore and grains, based on average prices paid for various shipping routes.