We hope this newsletter finds you well and looking forward to a more positive 2022, moving forward from the challenges of 2020 and 2021. To be sure, the last couple of years have been historic in their impact on society in general, so as we move into 2022, we would like to take some time to reflect and offer a look forward toward what could be ahead. Some of you may recognize parts of this, as this is an update and extension of a recent correspondence.
Only a year ago things were so different. Stock markets were surging in a renewed “risk-on” atmosphere and corporate earnings were expanding. Inflation was a threat but was only beginning to take hold. Consumer confidence was high, and demand was overpowering. American consumers continued to enjoy the stimulus funds provided to them through the pandemic. We were anticipating a mass reopening of the global economy, in hopes that Covid-19 was a thing of the past.
As inflation started to rear its head, the Fed initially characterized it as a “transitory” spike. As time passed, however, and many began to feel that it may be more of an enduring issue, talk in financial circles was about when what, and how much action the Fed would take to battle price increases without derailing the economic recovery. Balancing the need to increase interest rates (among other things) to slow the pace of inflation without derailing the economic recovery became more of a conundrum for the Fed as 2021 progressed. At the same time, concerns in the market that the Fed was behind the curve seemed to increase. This did little to interrupt the market run.
We came into 2022 expecting a series of increases in the overnight lending rate to begin, along with steps to reduce the bond-buying activity that the Fed had been engaged in since March of 2020. Other things being equal, many felt that the Fed could raise rates into a strong economy through 2022 and reestablish a more “normal” state of interest rates across the curve.
Cut to… the Russian invasion of Ukraine, trade/financial embargoes, and commodity prices surging, which has produced increased economic uncertainty. This is geo-politics. It is a ruthless business.
We at Atlas are very concerned about the humanitarian crisis facing the people of Ukraine, the refugees, and the neighboring countries that are struggling to provide for them. This is a disastrous situation that seems to have no defensible reason for having occurred other than the callousness of a dictatorial regime bent on conquering a territory that it wrongfully claims authority over. No invasion of a territory in recent history has triggered the kind of international opposition that this one has. Our hearts go out to all those families affected by this and we hope for a resolution soon. All that said, we, at Atlas, are not political analysts. We won’t attempt to predict how this will be resolved, nor are we intent on exploiting this terrible situation.
There is good news though. The U.S. economy is strong and continuing to expand. We do expect a decline from the strong 7.0% GDP performance of Q4 2021 in this year’s first quarter, but looking ahead we think that there is potential to see economic growth of around 3.0-4.0% for the year. Currently, the Institute for Supply Management (ISM) is showing both the manufacturing and services sides of the economy expanding nicely, constrained primarily by lack of access to labor and materials. Unemployment is currently at a very low level, so we anticipate that consumers should be able to continue to push the economy forward.
The chief challenge is inflation.
With the invasion of Ukraine and disruptions to several commodity supply chains; markets have been adjusting and repricing. As we know, 2022 is not off to an auspicious start with regards to either stock or bond prices. Interestingly though, S&P 500 companies overall have little revenue exposure to Russia and Ukraine. “The combined revenue exposure to Russia and Ukraine is about 1%.”1 So, the recent pullback may reflect market sentiment more than direct revenue risk.
Of course, with the impressive numbers put up by the S&P in 2020 and 2021, some level of correction might have been expected as we started this year. Hence, we would like to offer a few observations about market corrections and past market performances in times like these.
Historical data shows that over time, equity markets will (on average) experience the following bouts of volatility:2
- 3 corrections of about 5.0% per year
- 1 correction of about 10% each year
- a correction of more than 15% once every 3 years
- a correction of more than 20% once every 6 years
Some of these periods of volatility are precipitated by an event, others occur as a function of market or business cycles. In the case of the current correction, there may be factors at work beyond the Ukrainian crisis, but the cause is not the issue. The level of uncertainty, and subsequent market performance is.
Historically, U.S. equities have typically bounced back strongly after periods of heightened policy uncertainty, as measured by the Global Economic Policy Uncertainty Index. In the 12 months following periods where the Policy Uncertainty Index has exceeded 250, the S&P 500 has returned an average of 23.2%. As of December 2021, the Global Uncertainty Index stood at 269.853.
Along the same lines, bearish market sentiment can be a bullish indicator. Recently, market sentiment has been relatively low and heading lower. From current sentiment levels, markets since 1979 have averaged returns of approximately 8.2% in the following 6-month periods.2
It is important to recognize that this does not provide any assurance of an imminent market recovery. But, if history has taught us anything it is that when things look difficult, patience is a virtue, and we should remain confident in the resiliency of the markets. With that in mind, it is difficult to predict over what actual period a recovery might occur. Our view is that we could be facing continued heightened volatility in the coming months. The road ahead for markets may not be smooth, but as investors, we need to recognize that periodic negative volatility is to be expected, and we should understand how to deal with it. So, while the current headlines are justifiably concerning, they may not be sufficient reason to alter your investment strategy. We think that for those that have cash sitting on the sidelines, these times may provide an attractive entry point for investors that have a reasonable investment horizon and the ability to withstand some level of ongoing volatility.
As always, we continue to monitor the data and seek to make prudent and informed adjustments to our portfolios. As asset managers, we view the current situation as a time to adjust portfolios to cope with the present volatility and be well-positioned to take advantage of developing future opportunities.
If you have any questions about this, or any other financial issue, please feel free to contact your Atlas Wealth Management Advisor. We remain ready to assist you in your journey toward achieving your financial goals.
1 Butters, John. “Few S&P 500 Companies Are Commenting on the Crisis in Ukraine.” FactSet Insight – Commentary and Research from Our Desk to Yours, FactSet, 22 Feb. 2022, https://insight.factset.com/few-sp-500-companies-are-commenting-on-the-crisis-in-ukraine.
2 Fidelity Institutional CMSG Weekly Market Update, March 7, 2022
3 “Economic Policy Uncertainty Index.” Economic Policy Uncertainty Index, https://policyuncertainty.com/.