Q1 2022 Capital Market Highlights

Q1 Review:

Markets became significantly more challenging to navigate in 2022 as geopolitics exacerbated several of the risks present at the end of 2021. Headlines around the Russian invasion of Ukraine have displaced pandemic news as the major source of acute risk for asset prices. COVID concerns have largely dissipated outside of the impact that China’s zero-tolerance policies have had on supply chains. Inflation, which was already anticipated as a key risk for 2022, and its associated central banking response, have been compounded by the invasion. This has particularly been seen in higher energy and rising food prices, but also with additional supply chain problems. The resulting impact is that global growth is expected to be worse than anticipated at the beginning of the year, particularly in the Eurozone area, given its reliance on Russian energy. The Federal Reserve’s response to higher inflation has been to signal its intention to aggressively raise interest rates for the balance of 2022 and into 2023. This has resulted in significant weakness in the fixed income markets and has weighed on growth-centric companies.

Risks and Outlook:

Inflation, and how well the Fed navigates gaining control of inflation, continues to be the major risk to longer-term market returns. Outside of the most highly unlikely scenarios on the geopolitical side, the longer-term impacts of the Russian invasion are more significant in their exacerbation of existing trends than their potential to introduce entirely new long-term market risk factors. Inflation and skepticism around the reliability of global supply chains were already features of the economy in the post-COVID lockdown period. However, the Russian invasion appears to have worsened those trends. Neither are favorable for longer-term economic growth. This creates a multitude of challenges for Central Bankers to navigate. With inflation driven by demand outstripping supply and given their inability to fix the supply chain problems, it is hard for Central Banks to manage this dilemma without slowing the economy to the point that it damages the positive employment picture.

This risk is further compounded by a mismatch between shorter-term and longer-term inflationary measures. While the Atlanta Fed’s wage growth tracker is well above the level suggesting that risk is overheating, the expectations for inflation five years out are still relatively contained. Aggressively raising rates now to manage near-term inflationary pressures runs the risk of being overly harmful to the economy in the medium term.

On the real estate front, median home prices have increased 25% since early 2020. This appreciation can partially be attributed to the shortage of homes built over the past decade. Additionally, the move towards more remote working has caused an exodus from city living and a greater demand for suburban housing with more space since there is less of a need for commuting. The question now is how will rapidly rising mortgage rates impact the euphoric residential real estate market?

Despite all these risks, there are still many reasons to feel positive about economic growth in 2022. While Central Banks are signaling aggressive rate hikes, we are starting from a very accommodative posture where short term interest rates were at 0%-0.25%. It is hoped that these increases would serve to move us toward a neutral monetary policy, not a truly restrictive policy positioning that could damage long term economic growth.

Also, U.S. consumer spending accounts for about two-thirds of our GDP. Consumer balance sheets are currently in a very strong position, from a combination of multiple rounds of fiscal stimulus, reduced spending during the pandemic, and a very strong labor market. These should all serve as additional tailwinds to economic growth for the remainder of the year.

Assuming some of the geopolitical tensions become less acute by the latter half of the year, we anticipate 2022 to be a volatile but positive year for equity markets.

In times like this, investors are well served by the humble and wise words of billionaire hedge fund manager Ray Dalio, “Have a strategic asset allocation mix that assumes you don’t know what the future is going to hold.” In Q1, the Investment Committee made several manager and allocation changes due to our outlook. In summary:

• An Emerging Markets-based structured note matured at a significant gain in late January. Proceeds were reinvested in the Vanguard Total World Stock ETF for broad-based, low-cost, tax-efficient stock exposure.
• We increased our multi-cap value tilt by adding to the Vanguard U.S. Value Factor ETF.
• An S&P 500 based structured note matured at a strong gain in late February. Proceeds were reinvested in the Vanguard Total World ETF.
• We sold the balance of the JP Morgan Global Allocation fund. Proceeds were split to the Vanguard Total US Stock ETF along with portions to the Merger Fund and the Stone Ridge Diversified Alternative Fund to increase allocations to non-interest rate sensitive, defensive managers.
• In mid-March, an International Developed Markets-based structured note matured, and proceeds were invested in the Vanguard Value Factor ETF to increase our allocation to inflation hedging sectors like financials and industrials.

The market drawdown highlighted the diversification benefits of non-traditional fixed income managers and alternatives. Portfolio contributors were gold, and global natural resources, along with low volatility/absolute return vehicles. Portfolio detractors were emerging markets, international small-cap, and developed, international stocks.

As always, we are grateful for your continued trust in all we do related to planning and investments.