As we pass the halfway point of 2022 one thing is very clear; there is a growing feeling the future will not look like the past. It is reminiscent of a climber who sets out to summit a mountain on a beautiful crisp crystal blue morning only to see the clouds roll in and near the summit during a white-out blizzard. Of course, in investing, we never really reach a ‘summit’, but rather we must adjust our portfolios to ride out the storm.
Oh, what a storm it is! There is no shortage of things to be worried about. A quick survey includes a resurgent pandemic, supply chain issues, inflation, high energy and food costs, war in Europe, saber-rattling in Asia, and a possible upcoming recession. Let’s look at each in turn and see what may become of them.
COVID Redux
COVID continues to be an issue in parts of the world, although we are rapidly moving towards a begrudging coexistence. Most of the world has moved away from large government-based responses and in most places, it is being handled by individuals usually on their own. We are seeing spikes here and there and will likely continue to see those over the coming years, much like the flu. The exception to this is China where they are still locking down entire cities. This strategy will continue to cause supply chain issues.
Supply Chain Disruptions
While supply chains have started to unsnarl from their COVID-induced knots, China excepted, other issues are cropping up. The world is currently de-globalizing and countries look to have more control over the production of key goods. This will be a slow and, at times, painful process as it will not happen overnight. Companies (and individuals) will be forced away from highly efficient “just-in-time” inventories to more robust “just-in-case” inventories. What winners and losers come out of this process will be a key thing to monitor.
Inflation
Looking at inflation, we have seen it spike up to a level not seen since the 1970s. The Federal Reserve (and other central banks) have started to address these issues by raising interest rates. Increasing interest rates typically slow down the economy, but they take time to be effective. Imagine you were driving a car and when you pressed the brake it took ten minutes for the car to actually slow. That is how interest rate increases work. We are starting to see the beginning effects of interest rate hikes in areas like housing, commodities (oil excepted), and car sales. These are likely to become more pronounced over time.
Food and Energy Costs
Food and energy are highly interrelated as it takes a lot of energy to produce and move food. They have moved up together as inflation has moved higher. However, we may start to see a divergence. Food prices will likely stay elevated because the price increases in food are not just about the higher cost of energy. They include the Ukraine war as both Russia and Ukraine are large exporters of food and fertilizers and other countries who produce fertilizers are having issues as well. Energy on the other hand may see a dip if we do end up in a recession (see below).
War in Ukraine and Tensions Around Taiwan
The war in Ukraine continues well beyond what most thought was possible. Although there seems to be growing pressure to end the conflict, it is far too early to speculate on how or when that will happen, but hopefully for the people involved it is sooner rather than later. As for China and Taiwan, the status quo is the most likely scenario. The swift and deservingly harsh worldwide response to the Ukraine war has changed the perceived costs of aggression. No doubt efforts are underway to mitigate those costs should China decide to invade, but those efforts take time.
Recession Ahead?
Recession is rapidly eclipsing inflation as the most talked-about economic term. As a reminder, a recession happens when the economy shrinks. They are typically marked by higher unemployment and lower demand for commodities (like oil) goods (like houses) and services. We are likely headed for one, although it is not written in stone. We had a one-month recession at the start of COVID, which was one of the fastest and deepest drop-offs of economic activity in history. It was also one of the shortest as government action moved quickly to offset the effects of COVID. Before that, the last recession was 2008, also known as the Global Financial Crisis. Typically, a recession lasts on average, 11 months. During recessions, the Federal Reserve typically cuts interest rates to encourage economic growth.
Conclusion
Niels Bohr, a Noble prize-winning physicist once said, “Prediction is very difficult, especially if it’s about the future.” I’m not sure I’ve ever felt those words more sharply than at the current time. However, it is at times like these we return to the fundamentals. We are still adherents to asset allocation to diversify portfolios. While diversification is not a panacea to risks or loss, it should continue to provide benefits. Additionally, keeping our time horizon in mind is key. We’ve been through times of uncertainty and recessions before and staying the course (with perhaps some minor changes) has been a superior course of action versus trying to outsmart the markets by making large changes.
Finally, a note of caution. In today’s world of 24-hour news channels and ubiquitous social media chatter, it is easy to get caught up in various narratives. More often than not, those narratives are dire in nature. Most people can name at least one prognosticator who has predicted the end of the world or a significant calamity. Very few can name someone who said the world is changing and it will have both good and bad effects, but things will carry on. It’s worth acknowledging that those who predict very bad things may be more motivated by the notoriety they receive for catastrophic predictions rather than their ability to accurately predict.
We thank you for your continued confidence and trust during difficult times. while we always endeavor to meet with everyone on a regular basis, please always feel free to contact us with questions or concerns.