High Inflation Continues to Pressure Markets

To our Sandbox family, friends, clients and community,

Stock and bond markets remain under pressure and challenged as central banks around the world hike interest rates to aggressively suppress inflationary pressures.

In our below commentary, we cover the following:

• Net Worth Losses
• Stock & Bond Index Performance 
• 2022 Market Performance in Context
• Inflation Continues to Hold Markets Hostage
• Rising Interest Rates 
• Outlook and Investment Portfolio Positioning

Net Worth Losses

Through June month-end, Americans' collective wealth had fallen by more than $6.2 trillion from a record of $150 trillion at the peak in the fourth quarter of 2021. U.S. household net worth is in decline following a bear market in stocks and the worst year in bonds on record, offsetting cross asset gains in real estate values.

Source: Federal Reserve

Stock & Bond Index Performance

The decline in U.S. household net worth can be reflected by steep drops in stock and bond indices, which are off double digits from their respective high water marks. Equities, U.S. or otherwise, remain at/near bear markets (>20% declines), while bond prices (inversely related to yields) remain in a correction (>10%). As such, the traditional 60-40 stock-bond portfolio has suffered in light of this poor cross-asset performance.

2022 Market Performance in Context

2022 has been an exceptionally difficult start to the year. A 60-40 portfolio just experienced the worst eight-month stretch to start a year going back to the inception of the Barclay’s Bloomberg aggregate bond index in 1976. Just look at the red dot below – it’s visually striking how uniquely terrible 2022 has been for the average investor.

Source: Irrelevant Investor

Inflation Continues to Hold Markets Hostage

The reason for these messy markets? Inflation. Last week we learned that consumer prices, as measured by the U.S. Consumer Price Index (CPI), remain elevated, having increased +8.3% year-over-year. This caught most everyone by surprise because market expectations were firmly entrenched that inflation had peaked; this lead to heavy selling pressure on the rationale that the Fed will remain aggressive in hiking interest rates and had much more work to do in the months ahead. The Federal Reserve’s difficult proposition is fighting inflationary gains that are broad-based across many different categories: gasoline (+25.6%), health insurance (+24.3%), food (+11.4% YoY), new vehicles (+10.1%), shelter (+6.2%), etc. etc.

Source: Federal Reserve Bank of St. Louis

Rising Interest Rates 

As stated on the Federal Reserve’s website: “the Federal Reserve Act mandates that the Federal Reserve conduct monetary policy so as to promote effectively (1) the goals of maximum employment, (2) stable prices, and (3) moderate long-term interest rates.” The Fed seems to have accomplished (1) maximum employment – unemployment is near its lowest level ever at 3.70% and far below its long-term average of 5.7%. The Fed also seems to be (2) normalizing interest rates after a decade of zero interest rate policy (ZIRP) where rates were held at/near zero following the Global Financial Crisis in 2008-2009. So, it seems the Fed is now (3) actively addressing the final mandate – stable prices – by raising interest rates to decrease aggregate demand, increase the cost of money, and slow the economy down into the proverbial “soft landing.” The Fed has already hiked the Fed Funds overnight lending rate by 3.00% since March 2022 across 5 separate policy-setting meetings, with another ~1.5% of interest rate hikes in the coming months. The speed and magnitude of the rate increases is truly stunning.

Chairman Jerome Powell plainly stated the challenges we all face in his press conference at the Jackson Hole Economic Symposium: “While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses. These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain.”

Outlook and Investment Portfolio Positioning

We expect more volatility ahead given the difficulties confronting the market, however we feel the market should weather the storm as it has in the past. The consumer remains on strong footing, corporate earnings in the most recent quarter were better than feared, and the credit/liquidity markets are not showing imminent distress. We have repositioned accounts to maintain a defensive posturing to protect against further downside and the choppy waters ahead. For investors, we’ve raised cash throughout the year, reduced growth overweights, pared our bond duration exposure, and rotated into other investments that will hold up better in these environments – value-oriented plays, commodities, dividend-payers, structured notes, and real estate, to name a few.

As always, we remain at your service and are happy to address any concerns or questions you may have. Please reach out to your Sandbox Financial advisor  and we will arrange a time to speak at greater length.

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