by Kevin Slater, CEO, Lead Advisor, CFP®
The Fed has finally acknowledged what many have been communicating for some time; inflation is a real and persistent issue in the U.S. The problem of inflation is more complex than a temporary supply chain slowdown. Many blame Russia’s invasion of Ukraine, which has ballooned commodity prices of many types: oil, gas, grain, and precious metals. Certainly, it’s a factor.
But much like a noxious weed, inflation’s roots go deeper. Over the past few years, the economic policies of both Republicans and Democrats injected massive amounts of cash into all parts of the economy, including the markets. As a result, we have much higher housing costs, heavier consumer spending, and aggressive business expansion (paired with worker shortages).
By raising interest rates, the Fed is increasing the costs of borrowing and thereby reducing spending capacity. They hope to slow inflation from the current 8%+ rate to a target 2% rate. Their challenge is to slow the economy without doing major harm. This is difficult as some sources of inflation, such as commodity prices, may not be impacted by these actions.
The markets, as always, are trying to forecast the future. The bond markets have already priced-in additional interest rate hikes. The stock markets are assuming companies will not be able to grow as quickly and, in many cases, may need to contract. Where will consumers spend their money? How will each company be impacted by higher rates and reduced overall spending?
At SoundView, we don’t believe in “timing the markets.” In the short run, no one knows how the markets will react to inflation reports or Fed actions. However, as a firm we do make strategic changes at times based on significant economic shifts. We will continue to keep portfolios well-diversified and look for opportunities to add stability should the broader market continue to slide.
Our current focus with fixed income (bonds) is the preservation of capital. Bonds lose value when interest rates are rising so we have shortened duration significantly to reduce this impact. Once rates stabilize, we will extend duration to take advantage of the higher income offered from higher rates.
On the equity side, we have seen prices become much more reasonable according to traditional metrics. That said, the S&P 500 remains growth-biased and many of those companies have greater business risk as rates rise. On the other hand, even if the Fed triggers a recession, many companies will remain profitable and may outperform the rest of the market. We are exploring ways to balance this exposure without making a market call.
These are challenging times for investors, and we anticipate there could be more losses ahead. Even so, we believe in the long-term value of investing and the opportunities market corrections create.