Many markets entered a technical correction (defined as a 10 percent pullback or more) in January as headline inflation reached levels not seen since the 1980s and the Federal Reserve continued to shift its stance, becoming less accommodative. It is worth noting the level and pace of the pullback year to date is typical. The median intra-year drawdown in the S&P 500 since 1980 is 9.3 percent, yet the median annual return is 13.6 percent.
2022 started with a thud and plenty of market moving headlines. Omicron, inflation and the Federal Reserve, among other topics, weighed on the minds of investors. Most major indexes sold off with some crossing into a technical correction. Additionally, fixed income markets pulled back over the period as investors weighed new information from the Fed. Value stocks took a strong lead ahead of their growth counterparts to start the year.
Top of Mind
Inflation is on the minds of many investors, which came to the forefront as the Consumer Price Index (CPI) rose 7.0 percent over 2021, the strongest growth since the 1980s. The index was materially influenced by energy prices. Energy as a whole rose by nearly 30 percent and motor fuel was a primary contributor, up nearly 50 percent during the same time. In periods of rising inflation, capital intensive businesses with real (not accounting) assets on the balance sheet tend to perform better than businesses with intangible assets. The January pullback in intangible and technology-oriented companies fits this historical pattern as investors look to reconcile both higher valuations and rising inflation.
As a result of higher inflation, the Fed has been under pressure to stabilize prices. On January 26, the Federal Open Markets Committee (FOMC) announced they will hold interest rates at their current level (0 - 0.25 percent) but signaled it would “soon” look to increase rates to combat higher prices. Many Fed watchers interpret “soon” as March 2022. The Fed will continue to reduce its bond buying program and indicated it will seek to shrink its balance sheet (quantitative tightening, the opposite of quantitative easing better known as QE) only after it has begun to increase the Fed Funds rate. Fed Chair Jerome Powell noted “…I think there’s quite a bit of room to raise interest rates without threatening the labor market.”
Fixed income investors took note of the Federal Reserve’s recent actions. As a result, interest rates moved higher during the month. The higher move in interest rates, coupled with widening credit spreads, pushed bond prices lower. The broad fixed income market, as measured by the Bloomberg U.S. Aggregate Bond Index, returned -2.2 percent in January – the worst start to a calendar year since 1980.
While CPI figures in January were eyebrow-raising and may persist longer than some would prefer we believe they are unsustainable. A combination of cooling in the red-hot energy market, easing shortages of semiconductors and used car prices and unkinking of the global supply chain can help moderate headline figures. Early signs of easing can be seen in the ISM manufacturing data and the Baltic Dry Shipping Index, which moderated from highs in 2021. With that said, we do not anticipate inflation dropping to the one to two percent range we have seen over the past two decades. We fully anticipate a more robust inflation environment in the coming years at three percent plus.
We still believe bonds play a critical role in portfolio diversification to control volatility. However, investors should consider their current exposures carefully. Extended interest rate risk, low current yields and less accommodative monetary policies may reveal risks that were previously nascent.
Please let us know if you would like to discuss recent market moves. We are here to serve you and help you achieve your financial objectives despite swift market moves expected in the near-term.
 WSJ: Where Inflation Rose in 2021 in Seven Charts
 Fiducient Advisors - 2022 Outlook - Navigating Moderation
 WSJ: Where Inflation Rose in 2021 in Seven Charts
 U.S. Bureau of Labor Statistics
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