Some of you have been clients long enough to remember the birth of my first daughter 25 years ago. I am excited to share the birth of my first grandchild, born in March to my oldest and her husband. There is an old saying in the markets that, “The trend is your friend.” Following the trend, of course it was a girl.
A lot has happened in the past 3 months. The strong economic growth of the past year and half is beginning to recede. Additionally, inflationary concerns and supply-chain issues have been exacerbated by the conflict in Ukraine. A normal economic cycle has a trough and a peak, and while the Federal Reserve (Fed) works hard to smooth the curve, it is inevitable that the economy cools during certain periods. We believe we are at a crossroads with the Fed establishing a tough stance on monetary policy in the current year. We continue to navigate these trying times and invest accordingly.
A lot has been spoken about inverted yield curves signaling a recession. An inverted yield curve is defined as a shorter-term note paying higher interest than a longer-term note or bond. While inverted curves are atypical, they usually occur when bond traders are concerned about future economic growth. However, the markets can jump the gun and are not always correct. I have commented many times that my favorite joke that no one ever laughs at is, “The market has called 11 of the last 4 recessions correctly”.
For an inverted yield curve to have statistical significance, it would need to remain inverted for a few months not a few days. This is not the case now. While there may be areas of the economy that do slip into recession, the economic data still shows that the economy (Real GDP) will skirt a recession and have a soft landing in the middle of next year. The economy should continue to grow, albeit at a slower rate over the next 9-12 months. Our estimates for Western Europe are more pessimistic for a few different reasons including their closer ties to Russian energy.
What are some things to like about this economy? The consumer is very resilient right now as real incomes are up, employment is strong, and consumer debt is reasonable on an after-tax basis. While we do not believe the war will have a significant impact on our economy, economic numbers are distorted right now, e.g. inflation and oil prices. If this continues because of an extended war, we may need to adjust our targets going forward.
As for fixed income, it is off to one of the worst starts in a very long time. Currently, the iShares Core U.S. Aggregate Bond ETF (AGG), which is a basket of quality, intermediate fixed income notes, is down almost 8%. If you remember, we began hedging against this trend last year to protect our fixed income positions. With supply- chains coming back online, we had hoped inflation would begin to ease this year. However, given current circumstances we now believe inflation will remain elevated this year and have taken further precautions. We also believe the Fed will be more aggressive in raising short-term interest rates this year. The Fed is in somewhat of a bind as it must attack inflation while trying not to send the economy into recession. We will be watching closely.
In summary, we will continue to make adjustments as economic growth slows, the Fed tightens monetary policy, and inflation persists. We expect our portfolios to handle this period well. If you have any questions please let us know. As always, we value your trust.
Marc Henn, CFP®