Broker Check

What the Heck is Going On?

May 10, 2022

That’s how my wife put it this morning as we watched another abysmal start to the week for the financial markets. And that’s a wholly fair question to ask. So, let’s start with where we are now, then move on to why we’re here before looking at where we might be going next.

So where are we?

So far this year there’s been nowhere to hide in the financial markets. Looking at our benchmarks this morning, whether your allocation is almost wholly bonds or wholly stock you’re looking at being down double digits for the year. Oil is at a price we haven’t seen since 2014, and inflation is at a level not seen since the 1980’s. That inflation number means that even if you’ve been sitting in cash, you’re still facing a loss in purchasing power. That’s the bad news. For good news, unemployment remains low, we see strong optimism from small businesses, consumer confidence is at stable levels, and worker pay, once stubbornly flat, is on the rise and higher than it was a year ago. Overall, a mixed bag of indicators

Why are we here?

“Why” is always a tricky question when it comes to the economy and the financial markets. We all need to remember there’s a healthy amount of animal spirits involved, but two factors loom large: Inflation and rising interest rates. These two are linked. Central banks, like the Federal Reserve, raise interest rates to slow down inflation. This works by raising the cost to borrow so people and companies are less likely to borrow and likely to borrow less putting downward pressure on prices. Coincidentally, downward pressure on prices and spending means a slowing economy, which is generally bad. So, when it’s getting more expensive to spend and the economy could be slowing (but not necessarily shrinking), sentiment goes negative, and the stock markets tend to fall. Also, rising interest rates hurt the current value of outstanding bonds as new issues will pay more than older ones, which is why bond portfolios are hurting so badly right now.  In short, the combination of inflation and rising rates with an uncertain global environment is a recipe for the types of markets we’ve seen so far this year.

Where are things going from here?

To look forward, let’s first look back. The US government and Federal Reserve have been active in promoting economic growth for the last twenty years through low interest rates, bond buying, tax cuts, and government spending. Each of those measures adds to potential inflation by having more money moving around in the economy. Yet, inflation over that time remained low. I think what’s happening now is the bill finally coming due. Two decades of stimulus under both parties and enacted by governments of every persuasion coupled with the global supply chain disruption of COVID-19 has finally led to an environment where prices are heading higher, and action is needed.

OK, so what does that mean going forward?

My assessment is that we’re going through a major economic adjustment where we revert back to something like the 1980’s and 90’s, where higher inflation and interest rates were the norm. This also means a world where traditional portfolio theory becomes meaningful once again. Alex and I would love a world where bonds can provide a steady rate of return along with lower volatility, which bonds haven’t done in quite some time. That better world for bonds potentially lies on the other side of what we’re going through right now. To put it another way, what’s happening now is the bandage being ripped off with a new environment more favorable to savers and retirees likely to follow.

I hope that gives you a different perspective on what’s happening right now in the financial world. No one ever likes to see negative numbers, but in this case, I think it’s part of a sea change with big ramifications for the future. If you’d like to know more or want to ask a question about anything above, please contact me. And in the meantime, stay safe, stay healthy, and take a break from the news to take a walk in this lovely weather.