April 2022 Thoughts and Insights

Michelle Trouvé |

Happy Spring and Congratulations to all the Kansas fans, Rock Chalk Jayhawk!

We started out the year extremely cautious as we were concerned about slowing growth and slowing inflation heading into the new year. We reduced our stock positions and added gold to our portfolios, and positioned ourselves for a Quad 4/recessionary-like economy. What we did not know last December was that the first war in Europe since WWII would break out when Russia invaded Ukraine. Both equity and fixed income markets booked losses for the quarter, and gold gained. Fortunately for us, relying on math and data for our investments buffered our portfolios from larger drawdowns during this turbulent and emotional quarter. 

As we look forward to the second quarter, we still maintain this extremely cautious outlook and do not anticipate any major changes to our positions. 

 

Growth: Still Forecasted Lower

The two main components of GDP (growth) are private consumption and government spending.

As mentioned in last quarter’s note, we monitor over twenty-eight data indicators for GDP and we are beginning to see slowing growth in consumer services, manufacturing, business confidence and pending home sales. First quarter earnings season starts this week, and we anticipate declining growth as compared to last year in most sectors. 

Government spending will also be much lower as the Covid related stimulus from 2021 is not in the budget for 2022. 

 

Inflation: High, But Not Higher

The Quad 4 outlook maintains that inflation is slowing. It is important to not confuse “deflation,” where prices go down, with “disinflation,” where price increases continue but slow. It is also important to keep in mind that data is reported on a lagging basis.

Although inflation is at the highest level we have seen in many years, the data does suggest that inflation looks to be peaking. The three largest contributors to inflation are food, shelter, and transportation. 

In the food category, fertilizer, soy, corn, cattle, and hogs have already peaked. Wheat remains inflationary and is projected to peak in Nov. 2022.

With respect to shelter, rents peaked last July but due to yearly contracts will start to disinflate this July. Home prices also increased by 20% through last summer and are not expected to continue to rise this summer, especially with 30-year mortgages near 5%. 

In the transportation category, used car prices are now falling which is deflationary and shipping is poised to decrease during the second half of the year. Oil is one of the largest components of inflation and it continued to rise through early March reaching $130/barrel primarily due to the war in Ukraine. It has since backed off to $94/barrel today alongside oil volatility. Unfortunately, persistent higher prices will negatively impact growth as the cost to fill up the gas tank eats up household budgets.

 

Interest Rates: Continued Higher, But Not Much Longer

Interest rates continue to rise as the Fed started with a 0.25% rate in March, plans another 0.5% rate increase in May and then another 0.5% again in June. The Fed further plans “to cool” inflation by selling off the assets on their balance sheets, which acts as the equivalent of raising rates. 

When the Fed adopted a zero-interest rate policy in 2008, they knew the biggest risk of this decision could manifest when policy reversed from easing to tightening. If they raise rates into a slowing economy, they run the risk of creating a recession. Unfortunately, this is exactly the outlook: the economic data above points to a slowing economy at the same time they plan to aggressively raise rates.

Further pointing to recession is the inverted yield curve. The Fed raises short term rates which are reflected in the 2-year Treasury notes; however, the market drives the prices of the longer 10- and 30-year Treasury rates. Last month the yield curve inverted: the 2 year was priced at 2.44% while the 10 year was 2.38%. This means that investors prefer to lock in a rate 10 years out that is less than today’s rate. Inverted yield curves have historically predicted recessions.

 

Conclusion: Maintain A Cautious View

Given the economic and political backdrop, we do not plan any changes to our current investment line-up. In equities, we will maintain our positions in Technology (IYW), Berkshire (BRKB) and Broad Markets (SCHB/SCHY) albeit at smaller positions since we took profits last December and January. We own the defensive sectors of Healthcare (IXJ/PINK), Utilities (XLU), and Staples (XLP), and are currently studying Defense companies for a potential add. In fixed income, we reduced our credit risk last year and continue to own treasuries and income-focused investments. Lastly, we added back paper gold (GLD) to our physical holding security (PHYS), and we have a healthy position in cash, ready to invest when stability and opportunity returns.

We are grateful for your trust in us managing your investments. We are dedicated to serving you and, as always, welcome any questions you may have.

Michelle