U.S. and European central banks are committed to stopping inflation.
With five rate increases totaling 3% in 2022, the Federal Reserve moved swiftly to raise rates with the goal of tamping down the emerging inflation threat. Not since 1994-1995 have we experienced such a rapid and significant rise in rates. The Fed’s goal is to slow demand for goods and services so as to moderate price increases before inflation expectations become ingrained. While there are early indications that inflation may be moderating, the Fed has indicated that additional rate increases are likely, and it is premature to declare inflation dead.
Fixed income yields increased significantly this year.
U.S. Treasury securities maturing in two years now yield 4.2%, compared to only 0.7% nine months ago. While bond investors lost value this year, the prospects for earning higher interest in the future is positive. Our strategy of emphasizing shorter maturities compared to the overall bond market is paying off, limiting losses, and permitting portfolios to benefit quickly from the higher yields. Despite a return to a more normal interest rate environment, bonds are not yet producing a real, after inflation return. While they serve an important role in a diversified portfolio, they are unlikely to be drivers of long-term wealth accumulation.
The U.S. Dollar is strong.
Our currency is roughly at parity with the Euro, a level not achieved in 20 years. Increased demand for Dollars is due to relatively high U.S. interest rates, and a preference to hold Dollars given the geopolitical uncertainties. It is a good time for Americans to travel abroad, but the U.S. will likely see fewer foreign tourists this year.
Global equities are significantly down this year but within historical ranges.
The broad U.S. equity market is down 24.6% this year (Russell 3000 index). Stock markets outside of the U.S. are down roughly the same (-26.5% MSCI All Country World Index excluding the U.S.), partly due to the strength of the Dollar. U.S. corporate earnings have not yet declined, which means that this year’s deterioration in stock prices significantly changes the price to earnings ratio (PE), a key valuation measure. In short, stock valuations have become more attractive.
Diversified portfolios of assets are valuable in balancing risk and return.
A well-built home is both enjoyable every day and sufficiently strong to survive extreme weather. Similarly, investment portfolios should be designed with the appropriate level of risk to survive negative short-term events and achieve long–term goals. While we know that stock markets fall on average one year in four, experiencing the drop and doing nothing is hard. But it is what is required to achieve long-term goals. It is particularly difficult when we read or hear of war, inflation, and recession. Remember that economic data is based on what has happened, while financial markets reflect future expectations. Your portfolio will start to recover well before the news turns positive.