Two themes dominated the investment landscape to begin 2022 following a banner year for domestic equities in 2021. One of the best for The Tactical Allocation Portfolio (TAP) and its sub-models since its inception over a decade ago. We did not however dwell on the model’s success and immediately turned our attention to the new year and new although sometimes familiar headwinds.
It is understood everyone is experiencing the effects of the highest reading of inflation since the early 1980s. As core inflation, which excludes the more volatile food and energy sectors, reached 6.4% versus a year ago and the headline figure reached 7.9% it has inevitably reached each one of us. As well as those who are less fortunate. We say that as wage growth over a similar period was 5.8% so those living on a tight budget or are living paycheck-to-paycheck are in fact having to do more with less.
We have talked about consumerism in this newsletter in the past and while the economy grew at an above average rate in 2021 based on Gross Domestic Product (GDP), we view waning growth and a potential intermediate to long-term decline in consumer spending as the biggest risk to equity markets looking forward (note we made mention of this in our last newsletter). That is not to say we’re predicting a recession, for now the odds seem low, but something to be conscious of and will certainly add to the persistence of day-to-day volatility in global markets.
Shifting gears, we’ll look briefly at what The Federal Reserve, and other central banks around the world are doing to combat the current inflationary environment. First, The Fed is tasked with maintaining a safe, flexible and stable monetary and financial system. In addition to governing monetary policy. It goes without saying The Fed is currently seeking to tighten monetary policy by increasing interest rates, tapering bond purchases and reducing the size of its balance sheet. Thus, increasing the cost of capital and in theory reducing the number of dollars the economy has available to purchase good and services. This is no small task considering 3 trillion dollars in stimulus money injected into the economy over the course of 2020 and 2021. Frankly, we feel as though The Fed should have begun tightening long before it did and at a more aggressive pace.
In addition to what we’ve outlined above Russia invaded Ukraine on February 24th. This put additional pressure on already choked supply chains, helped to drive commodity prices higher and at least for a time added to a level of uncertainty across continents. The ripple effect across the EU and its energy dependence on Russia is likely not yet realized and something to watch closely as we embark on Q2.
So, what has this meant to start the year? Beginning in January equities stumbled and shortly thereafter reached correction territory of -10% from the most recent high as measured by the S&P 500 index albeit recovered off lows to end Q1. Bond yields spiked across the yield curve causing meaningful losses in the fixed-income arena. As stated above commodities prices spiked adding to inflationary pressure.
All of this seems a bad recipe and yet TAP and its sub-models navigated the associated risk closing out the quarter with just fractional losses when compared to all three major market indexes. The equity model shifted from growth to value all while maintaining an above average allocation to cash. The shift to value focused primarily on the energy and defense sectors when embracing even small exposures to risk. The fixed-income model first took pause maintaining a 100% allocation to cash and then embraced a different approach, investing exclusively in short-term U.S. Treasury Bills in the later part of the quarter. All of this served the models and investors well in an otherwise turbulent Q1.
Please keep an eye on our Weekly Market Updates to stay informed given current conditions and do not hesitate if we can help you, your family or your business during these uncertain times.
Fraser, Dudley, Alex, Josh, Christie & Melanie