Caution – Speed Bump Ahead

Last year at this time we were reporting that the Fed had announced they intended to keep interest rates low through 2023.  It is a different story today.  The Fed has signaled that it could conceivably raise interest rates three or possibly four times this year.  Yikes!  That is quite the change.  The reason?  Simply put – inflation.

The Fed was willing to give inflation some room to run last year and gave us a new term by way of explanation – transitory.  They anticipated that the demand created by various stimulus packages from the US Government would create transitory inflation.  It would spike for a time and then retreat once people spent their stimulus checks and more Americans got back to work.  It was a valid theory, but the demand side economics may have gotten turbocharged by unanticipated supply side shortages, largely due to the global effects of the Covid pandemic.  The result?  The cost of goods as measured by the Consumer Price Index (CPI) tells the tale – from December 2020 to December 2021, food prices increased 6.3%, home prices increased 6.5%, energy prices increased 29.3% and gasoline prices increased 49.6%.  (Source: bls.gov/cpi/)  Inflation may still prove to be transitory, but it is having an impact that the Fed can’t ignore.  They are tightening the belt, and they do this by raising interest rates and dialing back quantitative easing.

What this means to us is that asset values will see downward price pressure.  For example, higher interest rates will make the banks charge higher rates for us to take out home mortgages or loans to buy cars, so we can borrow less money.  Over time, this starts to stifle demand, and the prices of houses and cars will be under pressure to decline.  Higher rates will make it harder for small businesses to borrow money and more expensive for big businesses to issue new debt.  This, in turn, makes it harder for them to grow, hire, compete and make profits.  Lower profits make company earnings less appealing to investors, which could affect the value of stocks.  It is a ripple effect and it takes time to unfold, and let us be clear in saying that none of these forces operate in a bubble and there are many other factors that will have an impact.  Covid 19, foreign aggression, political infighting and social unrest will continue to be a backdrop to whatever the Fed does with interest rates.  

We are not suggesting that this is the time to sell everything and bury your money in the back yard.  We are simply advising caution.  In any given time period, the market is going to have declines, advances and periods of little or no growth.  The different sectors of the market are going to react differently to these various pressures.  2022 might be the year when international and emerging market equities finally outperform US equities again.  Small cap stocks and large cap stocks will be impacted differently, as will growth stocks and value stocks.  Asset classes that are not highly correlated to the S&P 500, like gold and real estate, may have more appeal in the coming months and years.  And it is anybody’s guess as to what will happen with Bitcoin and the other cryptocurrencies.  

This is a great time to make sure that your overall asset allocation is appropriate for your risk tolerance and time horizon.  We may be entering into one of those periods in the market that will test your pain points.  We have many lessons behind us of people who threw up their hands in surrender and got out of the market when it was at a bottom.  It is difficult to recover losses with that approach.  Investing in the market is not a game of chicken.  Proper investing requires planning and preparation.  We have been down this road before.  You just need to pay attention to the road signs and not get caught staring at the billboards.  

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