A Motley C.R.U. of Market Pressures

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A Motley C.R.U. of Market Pressures

Market pressures persist into the second quarter of 2022, though we continue to see a way out for both stocks and bonds over the medium term. So, what’s got markets on edge this time? Investors are selling both risky assets and safer securities amid an unwelcome visit from a motley “C.R.U”. (China, Russia, and Unemployment).

Supply shocks from China and Russia have boosted energy, food, and goods prices, while low unemployment is driving U.S. wages higher. These inflationary factors have set off a string of events including 1) Federal Reserve tightening actions, 2) lower bond returns as interest rates rise along with inflation, 3) a potential cooling of business investment and consumer spending, and 4) a rising specter of another recession.

Stock markets in recent days seem to be jumping to conclusions about how these falling dominos will impact company fundamentals, as seen in a few high-profile disappointments from companies such as Amazon. Corporate profits are still growing but inflation may start to depress growth rates, which might add to market volatility. This client letter will profile the members of the Motley C.R.U. and explore scenarios for what’s next. Will this be a one-hit-wonder, or will this band play on for some time, to the irritation of fans everywhere?

China: Covid stuck on repeat

Just as many in the Western world began recovering from Covid’s Omicron variant in February and March, the Chinese government began instituting severe Covid lockdowns in major cities like Shanghai in April. These restrictions have slowed consumption while also cutting into manufacturing, adding another painful layer to the global supply chain pressures stemming from the pandemic.

Logistical delays among Chinese manufacturers have added to the cost of global trade and inflation in the U.S. as consumers pay a higher price for more expensive imported goods. Multinationals with exposure to China have reduced profit expectations amid the latest wave of Covid lockdowns in China. These lockdowns may continue for weeks or months until natural immunity spreads, better vaccines reach citizens, or China’s leadership decides to hit pause on its zero-Covid policy.

Russia: The hits keep on coming

In addition to the obvious humanitarian disaster, Vladimir Putin’s invasion of Ukraine has set off a series of supply shocks for oil, gas, industrial materials, fertilizer, and wheat production. Russian aggression has affected the global economy through higher commodity prices and shortages.

Commodity buyers in Asia, Europe, and the U.S. are now paying higher prices at the gas pump and in grocery aisles, especially as democratic governments change energy policies to stop funding Russia’s war in Ukraine. Looking ahead, we could see gas and food prices fade if Russia and Ukraine resolve their conflict this year. However, in an economic downside scenario, pressures may ramp up if Europe stops importing Russian oil and gas—a move that could threaten German manufacturers.

Unemployment: You can’t always get what you want

A final theme that has raised investor angst is a hot job market and historically low unemployment, both of which have added fuel to the inflationary blaze and drawn the attention of the firefighters at the Fed. Rising consumption and business investment have boosted demand for workers, while early retirements, Covid-related disruptions, and perhaps extra stimulus cash have crimped the supply of job seekers.

On May 4, the Federal Reserve raised the Federal Funds rate by a half a percentage point, the largest rate hike since May of 2000. Chairman Powell is attempting to orchestrate a soft landing for the economy, a balancing act whereby the Fed can slow the economy a bit and reduce hiring pressure while avoiding putting people out of work. A more balanced job market may reduce wage pressure and lower overall inflation. However, history suggests that Fed rate hikes more frequently lead to recessions than successful soft landings.

At the moment, the Fed seems prepared to raise interest rates by another half-point in June and then again in July, while also starting to reverse the money printing process that helped the economy in the depths of the pandemic. Jay Powell indicated that the Fed is unlikely to raise interest rates by more than a half-point, triggering a modest relief rally for stocks yesterday afternoon.

So what’s next for the economy and markets? Investor fear and pessimism remain elevated, generally suggesting that neutral or favorable news may boost investor sentiment. Still, we see a rocky road over the next few months as the motley C.R.U. goes on a summer tour. Over the longer term, we expect inflation to fade, interest rates to remain well below historical averages, and corporate earnings to keep marching on. These more favorable long-term themes and a disciplined approach to equity ownership through market cycles will help to avoid emotional or dramatic overreactions, which tend to depress portfolio returns.

We will continue to follow these economic and financial events as we evaluate investment approaches, upside opportunities, and downside risks. Our research and portfolio management process continues to uncover opportunities that meet our core investment principles, remaining ever mindful of your goals and objectives.

We wish you all the best as summer approaches.

Michael Bailey, CFA
Director of Research

Michael Mussio, CFA, CFP®
President

 

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