This past week saw some of the worst-performing market sessions since 2020. While we understand that those days can be tough to stomach, we also want to be conscious of the groundwork that can be done to prepare for them and remind ourselves that downturns are a part of the investing process. We wanted to share a few thoughts on what we’re seeing, how we’re positioned to handle this downturn, and why we remain confident moving forward.
Uncertainty Begets Volatility
Underlying the market’s recent erratic behavior is the significant amount of uncertainty in the world right now. The conflict in Ukraine continues to impact energy prices, and the longer it draws out, the more likely we’ll continue to see near-term pressure on petroleum. It is expected that, over time, some of that pressure will be relieved as the U.S. and Europe find other sources of energy and Russia finds other buyers.
In China, a zero Covid policy continues to place stress on their economy. Consequently, supply lines continue to be depressed, causing goods to cost more and contributing to inflation woes. Again, this is likely a short-term problem as China seeks to get current Covid cases under control while the rest of the developed world rebuilds their supply chains to be less dependent on a single provider. Over time, some of these pressures should ease.
In the U.S., many companies have recently missed their earnings targets, contributing to the market selloff. This is unsurprising, given that inflation has slowed down consumption. Not only that, but during the pandemic, consumers “borrowed” from future purchasing – meaning that while they were stuck at home, unable to spend on entertainment and travel – those with extra cash made a purchase earlier than they might have otherwise. An individual planning to buy a car five years later may have chosen to buy one during the pandemic instead. This borrowed spending can also cause short-term pain for companies as it slows consumer purchasing until their needs catch up. Unfortunately, we don’t know when that will be, and we will have to wait while companies adapt to new consumer demands and spending habits.
In addition to geopolitical and consumer uncertainty, high inflation continues to rattle financial markets. This morning, inflation numbers were released and while they showed inflation had slowed slightly, the numbers were still higher than expected, causing markets to drop further. While the topic of inflation has been thrown around a lot in the media recently, it’s important to remember that inflation is part of the economic cycle. Given all of the money recently pumped into the economy during the pandemic, it’s unsurprising that things cost more. As the supply of money dries up, demand will lessen and, when paired with recovering supply chains, should cause inflation to ease over time. This doesn’t necessarily mean that the price of things will drop; it simply means the cost of goods and services will start to find the proper equilibrium between what is available and what is desired.
To help aid this process, the Federal Reserve has committed to slowly raising the fed funds rate which will raise interest rates for other types of borrowing, including commercial lending and mortgages. This makes money more expensive, which helps constrain inflation. At the same time, if money becomes too expensive, it halts the economy. The Federal Reserve must find the right balance of raising rates at the right pace. They are very aware of this and have indicated they don’t want to raise rates too quickly, which has eased some market fears.
Where We Stand
We continue to believe in the strength of our investment strategy, particularly given the current economic environment. Our portfolios currently maintain a tilt towards value that has historically performed well in inflationary environments. As you may remember from your high school economics class – a dollar today is worth more than a dollar tomorrow. This is particularly true when facing high inflation, and because value companies tend to have more stable earnings than growth firms, they often do better when prices are quickly rising.
On the bond side, we tend towards lower duration in the funds we’ve chosen to utilize. Because duration measures interest rate risk, lower duration is desirable in environments with rising rates. This fares well for the bond side as the Federal Reserve looks to continue raising rates over time.
Weathering What’s to Come
While we expect to face continued volatility in the weeks and months to come, we remain rooted in our philosophy that planning should drive our investing. We stress test all of our financial plans for these types of downturns to see how your plan might withstand market volatility. To that end, we do not intend to make any major changes to our current strategy, but may rebalance into the downturn to take advantage of inexpensive assets. In the interim, we know large downswings can be unsettling, and we’re happy to walk you through your plan and your portfolio. We’d also like to invite you to join us for our upcoming Family Wealth and Values conference in Westlake Village, where we’ll be sharing a little more about investing in this environment and how we’ve chosen to position our portfolios in light of your financial goals. If you would like to RSVP for yourself or a friend and haven’t already done so, you can find more information here.