2022 First Quarter Commentary: Don’t Fight the Fed

There was no shortage of uncertainty for investors to digest during the first quarter of 2022. Taking center stage was the war on the European continent – which is a shock that has yet to be fully understood in terms of its longer-term political, economic and market impacts. However, the latest developments suggest that a new geopolitical landscape is in the making – one that divides the world into spheres of nationalism vs. globalism. Forecasting the war’s end is anyone’s guess, but a more deglobalized world certainly points to a higher inflationary regime. And while the Russian and Ukrainian share of GDP may be small on relative terms, we are already seeing the short-term inflationary impacts given the war’s disruption of supply chains and global commodities supply.

In this commentary, we re-examine our past views for 2022 and dive further into what may come next for the markets and economy.

COMMENTARY HIGHLIGHTS:

  • Each of the primary risks from our cautiously optimistic fourth quarter 2021 commentary has become more apparent and caused turmoil in both stock and bond markets during the quarter. Despite the various narratives being offered by the street in making sense of these new developments, it is our opinion that inflation is the true driver of underlying market pricing.
  • Consumer prices continue to rise given the sustained demand and supply pressures. Additionally, growing inventories and slowing production may be signaling the early signs of demand destruction from the elevated price pressures. However, the economic outlook remains incredibly difficult to forecast given so many risk factors that are currently in play.
  • At last, the Federal Reserve has communicated to the market last quarter that it is shifting gears with its policy to fight off inflation and raised the overnight borrowing rate by 0.25%. The yield curve has meaningfully repriced on the front end to reflect what may be the new path upwards over the next year for short-term interest rates.
  • The saying “don’t fight the Fed” certainly worked for investors this last cycle. We think the inverse is also true. As money becomes scarcer, and expensive, price discovery will take center stage.
  • Investors continue to heavily favor mega-cap stocks. Yet, over the last year, the top 10 stocks of the S&P 500 Index’s contribution to earnings have fallen by nearly -30%. Going forward, we question the reliability of earnings growth of even the largest corporates at these types of valuation premiums.
  • At present, we are of the view that the economy is on a less-optimistic growth trajectory than previously forecasted. Lower economic growth, higher inflation and rising borrowing costs will likely create more volatility across risk assets. We are reliant on alternative strategies more than ever to help us navigate the road ahead.

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