As most all of us are aware by now, financial markets have been off to a rocky start to 2022. After several very strong years for stocks, this recent pullback is not, statistically, unexpected or unusual. However, there does seem to be more than the usual number of concerns in the financial markets now. In no order:
- The upcoming Fed tightening. The Federal Reserve has made clear that they will be raising interest rates and reducing their balance sheet to combat inflation. It is always a tough time for stocks and bonds as they adjust to a change in Fed policy.
- The Russian threat to Ukraine independence. For a month, there had been growing tension about the possibility of a conflict. Last week, we witnessed an invasion and the beginning of a war. The markets must now interpret how global sanctions will impact oil prices and economies beyond the intended consequences for Russia.
- China’s intentions. While the world focuses on the Ukraine crisis above, does this embolden China to make an aggressive move on Taiwan?
- Economic disruptions from Covid. The disruptions are still impacting supply chains and employment. As Covid seems to wane in the US, it is still flourishing in other parts of the world. How long will it continue to impact world economies?
- Stock market performance. On Thursday 2/24/22, most major US stock indexes traded in correction territory (a decline of 10% or more) early in the day. Although the markets have rebounded, is the poor performance to start the year just the tip of the iceberg?
- The second year of a presidential cycle.Historically, the second year of a four-year presidential cycle, regardless of Democrat or Republican, has been a tough year for the stock market. In particular, the first half of the year tends to be rough before rallying in the second half of that same year. Although this pattern is known, it is not consistent enough to invest around.
With all this doom and gloom, it’s hard to maintain a sense of humor. However, as I was preparing to draft something for all to read, the list above reminded me of something funny from my youth. In the late 1970’s, I was a teenager staying up late on Saturdays to watch the original cast of Saturday Night Live. Gilda Radner played a character reporting news called Roseanne Roseannadanna. The tag line to her recurring sketch was, “It just goes to show you, it’s always something. If it’s not one thing, it’s another!” The stock market did not have to go down this year. It was certainly due for a correction and this current one may be over, or we may go lower. We never really know what causes a correction until after it has passed. Markets correct occasionally (if not for one reason, then for another) but more often than not, financial markets go up. That is why it pays to stay invested, even in the rough times, even given the realities of what is happening in Ukraine. We will share with you some interesting data from our mutual fund partners on how the markets react to these types of events.
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The first piece we would like to share was provided by Capital Group, who manages the American Funds. In a recent article discussing the Russia/Ukraine conflict, they provided the following chart that shows that we have been here before, and through it all, the market continues to climb higher. When we are living in the moment of one of the geopolitical events outlined in the chart below, we tend to concentrate on the worst. In the event of war or terrorist attacks, we think about loss of life and wonder what the world will look like after the war is over. From there, our thoughts go to our money and investments and, once again, our initial reaction is to think the worst. But as you can see below, after some typical jitters around the event, the market moves on.
Interestingly, the timing of the geopolitical event is very significant. If the event happens when the economy is struggling, the market will not necessarily bounce back quickly. The terrorist attacks on 9/11 occurred when the US was still recovering from a recession that lasted from March 2000 through November 2000. Although we were no longer in recession on 9/11, the economy was still struggling as growth remained below trend. On the other hand, both Gulf Wars occurred when the economy was on firm footing and the markets recovered very quickly from these events.
Another mutual fund family that we partner with is Vanguard. Vanguard provided the chart below that shows that geopolitical sell-offs are typically short-lived.
In Vanguard’s example above, it is important to note that apart from Nixon’s impeachment proceedings, the market was in positive territory six and twelve months after each of the events. Fortunately, there are not enough of these geopolitical events to gain statistical significance to invest around these trends. We simply look back at history to help ourselves and our clients remain calm and stay invested. Although it seems different this time, the markets have come through similar situations.
Right now, the US economy is reaccelerating as we move past the latest Covid variant. The equity markets have corrected, and we have a witnessed a contraction in P/E multiples. The good news is that to date, this was more of a valuation adjustment than a correction due to faltering earnings. In fact, earnings growth remains positive and is supported by GDP. Going forward, the elephant in the room remains inflation. The Fed is committed to slowing inflation, but how fast will they have to act? The speed and size of Fed action will likely affect the markets more than the Russia/Ukraine conflict. We will continue to monitor a very fluid situation and will communicate any changes through your consultant teams.
If you have questions about this information or your overall financial plan, call us today at 412-630-6000. Our experienced financial advisors are here to help.
Mike Kauffelt, CFA
Tom Beilstein, CFA
Co-CIOs, Bill Few Associates, Inc.