Beginning last spring and continuing through 2022, rising inflation has become the dominant factor, both spooking markets and squeezing the already tight budgets for millions of Americans. Global supply chain disruptions continue as China and other countries lockdown their economies to battle COVID. Shortages of computer chips, new and used cars, furniture, battery materials, paper, food, and many more goods are driving the prices up for the limited supplies available. The Russia-Ukraine conflict has only exacerbated the problem by disrupting the global energy markets and driving up the price of oil and gas. As of March, the U.S. inflation rate reached 8.5%, the highest since 1981.
Because much of the current inflation is due to temporary disruptions, the longer-term expectation is for much lower levels. Current prices for Treasury Inflation-Protected Securities (TIPS) imply the market expects inflation to run on average less than 3% over the next ten years.
With inflation continuing to rise, the Fed has pivoted away from their neutral, wait-and-see approach to a more aggressive tightening plan. In March, they raised the short-term Fed Funds rate by 0.25%, marking the first increase since cutting rates to effectively zero in response to COVID. Short-term rates in the U.S. are projected to reach 1.9% by year-end, with more Fed tightening expected. The change in Fed policy has rattled the bond market leading to one of the worst quarters for bonds in recent history. The bond sell-off has continued through April, leaving U.S. Bonds down roughly -9% as of the writing of this article. When rates go up, bond prices go down, which is a headwind for current returns. But over the longer run, higher rates mean higher income and, thus, higher future returns from bonds which is a good thing. Among developed nations, the U.S. offers a relatively attractive yield for bond investors, with Australia, Japan, and most of Europe near 0% or even negative in some instances.
Equity markets have reached their 2nd anniversary from the 2020 COVID-induced crash. The S&P 500 has since doubled, marking the strongest 2-year performance in over 70 years. It has been mostly a smooth ride, but we did experience a “correction,” or a fall of -10%, in February. Historically, corrections are quite common and occur every 2 years on average. Given the strength of this 2-year bull market, a correction feels healthy. Bear markets are defined as a market fall of -20%, and market crashes are defined as -30%, which also occur regularly over enough time. On average, we expect a bear market every seven years and a crash every 12 years. However, they do not occur on a set schedule. The best response to challenging markets is always stay the course because this too shall pass.
Author: Jim Rambo, CFA | Research Team | Allegheny Financial Group | April 2022
The information included herein was obtained from sources which we believe reliable. This report is being provided for informational purposes only. It does not represent any specific investment and is not intended to be an offer of sale of any kind. Past performance is not a guarantee of future results.
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