First Quarter Investment Commentary 2022

Dennis O'Keefe |

"May you live in interesting times."  We're certainly in those times.  After surviving two years of a pandemic, we face a potential war with global implications on top of record inflation the likes of which most Americans have never experienced.  It's like we are reading accounts of the world 100 years ago.


Our financial markets have reflected the tumultuous times of the year.  At one point this quarter, the S&P500 had declined 13%.  The NASDAQ and other indicators had fallen over 20%.  (The stock market recovered significantly.  Through the end of the quarter, the S&P was down only about 5%.)

Of the three major socio-economic issues we faced this quarter, inflation is the most significant.  In the short term, its effects are minor.  But longer-term, it can slow down or even stop our economy.

The root cause of the inflationary spike is not Covid-era supply chain issues or the increase in petroleum products due to war in Ukraine.  Instead, the root cause is the massive increase in government spending over the last two years.

Historically, we've associated government overspending with higher inflation.  One always led to the other.  But for the last thirty years, we've had such low inflation that we've forgotten this rule.

Stalwarts in Congress whose terms extend into the 1980s and beyond forgot as well.  It seems everyone in Washington DC assumed that the US government could borrow its way out of any crisis without consequence.

This is a major reason for the derailing of any of the Biden agenda on domestic spending.  Not only Republican but many Democrat Congresspeople are reluctant to do more to exacerbate the current crisis.   

In addition, the crisis has changed the current goals at the Federal Reserve.  For a decade or more, I've mentioned in my blogs and emails that the Federal Reserve has ignored the potential problems of forcing abnormally low rates on the American public.  

To refresh your memory, not only has the Fed used it's powers to keep interest rates low since 2008, it has also purchased over $8 trillion in government securities in order to force these low rates.  

Effectively, the Fed has created $8 trillion in dollars out of thin air.  

Here is the good news:  The Fed, under Chair Jerome Powell, seems to have seen the light - albeit a bit late for my tastes.  

The current Fed goal is to raise interest rates 10 times in the next 18 months.  That will bring short-term interest rates from near zero to over 2.5%.  And any concern over economic issues outside of inflation do not seem to deter the organization from its goals.

In addition, the Fed is working on a plan to reduce the $8 trillion in bonds within the Fed's pocketbook to a nominal level - probably $500 billion or so.  

Both of these measures have significant effects for our next economic downturn.  Without higher interest rates and a smaller balance sheet, the Fed will be unable to do anything to mitigate the effects of our next recession.  

(A quick aside - just like all other organisms, the economy must go through periods of "rest" in order to continue to grow - much like a tree.  The rings of a treemap out the times of growth and rest.  Likewise, our economic cycles are defined by the recessions that separate them.  Recessions aren't enjoyable but are necessary in order for our economy to grow.)

The more important result of the Fed's efforts will be a reduction of inflationary pressures.  Higher interest rates will decrease corporate borrowing and slow out-of-control growth within companies.  Eliminating the bonds within the Federal Reserve's portfolio will pull money out of the economy, directly counteracting the effects of inflation.

How Will This Affect Us, the Consumer?

There are two effects that consumers will see in the coming months and likely years.  

The first is an increase in the interest rates of our savings vehicles.  This means higher interest rates at your bank for CD's and short-term bonds.  Given that inflation is eating into the principal of these accounts, an increase in rates is a welcome sight.

The second is an increase in mortgage rates.  We are already seeing that occur already.  Rates for a 30-year mortgage that were in the 3.5-3.75% range at Christmas are hovering at 4.5% today.  

Imagine if rates rose another 2% over the course of the next 2 years.  That would certainly put a damper on the real estate market.  For reference, someone who could afford a $500,000 mortgage at 3.5% could only afford a $375,000 mortgage at 6%.  That's a massive difference.

Will this lead to a collapse of the real estate market?  Probably not.  The change is occurring over two years, making the changes gradual.  

What is likely to occur is that we will see less buyers at each price point.  This means an end to the bidding wars that have dominated real estate for the last 2 years.  It will also mean that homes will stay on the market longer - leading to much more inventory.  

Prices will likely hold.  They may fall a bit.  But after the massive gains in the real estate market over the last 2 years, a bit of a pullback is not unexpected or potentially a terrible consequence.

Other Economic Observations

Pockets of inflation are still appearing all around us.  Food costs seem to be up, but there are still opportunities to buy items at 2020 prices.  Construction supplies continue to sell at multiples of their 2019 prices - mostly due to a pandemic-fueled building craze.

Gasoline continues to be expensive as well.  This is in part due to the war in Ukraine but prices have been climbing since the Summer of 2020.  If we had peace in Eastern Europe tomorrow, prices would drop but not significantly.  Worldwide demand is up and worldwide production has not increased enough to meet demand.

I watch gasoline prices on a daily basis.  The price fluctuations are staggering.  Gasoline futures seem to trade up or down 5% or more per day.  

I suspect that pump prices will fall in the coming weeks, but I see it unlikely to drop under $3.80 per gallon here in the Northeast without a halt to the Ukraine conflict.  Even then, I believe prices will hold over $3.

Despite all of this, the US economy continues to move forward.  While labor is tightening, we are seeing growth that will help justify higher stock prices in the coming months.  My estimate is that the economy and market will continue to rise over the remainder of 2022.  

Thank you for your trust and support.  Happy Spring.  If you have questions or concerns regarding the stock market or any financial issue facing you, do not hesitate to get in touch.

Stay safe.

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This blog is the opinion of Successful Money Strategies, Inc. and is provided for informational purposes only and is not intended to provide any investment advice or service.  Statistics and other figures are accurate at the time of original publishing.  Any advice herein should not be acted upon without obtaining specific advice from a licensed professional regarding the reader's own situation or concerns.  Always count your change.