Third Quarter Outlook, Portfolio Strategy | News, Sports, Jobs – SANIBEL-CAPTIVA
PROVIDED PHOTO Andrew Vanderhorst
To say that investors experienced a roller coaster ride in the markets during the second quarter is an understatement. We saw the S&P 500 close 20% off the benchmark’s January highs to officially enter bearish territory in June. Meanwhile, yields on 10-year US Treasuries have more than doubled since the start of the year, recently hitting 3.36%. What can investors attribute this volatility to? The main culprits are concerns and uncertainty about inflation, both in the US and globally.
June’s Consumer Price Index (CPI) report showed headline inflation of 8.6%, up from previous months’ report and beating economists’ consensus estimates. While not everyone may be buying the exact basket of goods measured by the CPI survey, most of us have probably experienced the rising price of gas and groceries. . Even if we remove these volatile components of gasoline (energy) and groceries (food) from the report, inflation still measured a 6% year-over-year increase. This level is well above the 2% inflation target set by the Federal Reserve Board and increases investors’ fears that the Fed will have to take more aggressive measures that could lead to a recession.
Identifying the exact origins and causes of the current US inflation is the subject of significant debate and disagreement among economists. However, it is reasonable to consider some key factors that probably explain most of the situation. First, the unprecedented shutdown of the global economy prompted significant fiscal and monetary stimulus as governments and central banks struggled to avoid a prolonged global recession. Central banks began to withdraw this monetary stimulus by raising short-term rates and shrinking their balance sheets (quantitative tightening). Following higher than expected inflation readings, our Fed raised interest rates by 0.75% on June 15 and noted that “ongoing increases… will be appropriate” to bring inflation back to the Fed’s 2% target.
Second, the four-month war in Ukraine has reduced world supplies of wheat and oil. Europe recently implemented sanctions against certain purchases of Russian oil, which will lead to a decrease in the overall supply of oil available in the market and, therefore, keep oil prices high. Although the United States does not import Russian oil, we are not immune to market dynamics. Although a final conclusion to the war is not in sight, a relatively amicable solution will give energy and food markets a much-needed reprieve and curb inflation.
Finally, Chinese President Xi Jinping continues to implement a zero-COVID policy forcing mass shutdowns of entire cities, especially those critical to global supply chains. Such a policy can aggravate inflation as fewer goods are produced and delivered relative to growing consumer demand. During the pandemic, many companies have recognized the hard lessons learned from consolidating supply chains around China, but moving manufacturing facilities and establishing new suppliers in the supply chain takes time. Unfortunately, China’s zero COVID policy is unlikely to be reversed and will continue to negatively impact supply chains and inflation.
We will likely continue to experience market uncertainty and volatility as the above variables evolve over time. Naturally, this will lead to investors reacting positively or negatively to monthly data points as they try to get a feel for the future. As in the past, we expect the roller coaster to bottom out and begin its inevitable ascent. Long-term investors who invest in high-quality companies will be rewarded during the recovery, but only if they stick to their long-term asset allocation. For those wishing to reduce their risk, it may be prudent to have modest allocations in short-term bonds or cash for future lifestyle expenses.
Andrew Vanderhorst is Chief Investment Officer for The Sanibel Captiva Trust Company.
