We just closed out the first quarter of 2022 with some historic numbers. Capital market volatility increased notably in the quarter and asset class returns were almost uniformly negative as the Russia/Ukraine conflict, the Fed’s rate hike campaign, elevated inflation and rising interest rates weighed on investor sentiment. Both equity and bond markets declined during the quarter, a rare event that has occurred only 16 times since 1976.
At the end of March inflation reached 8.5%, the highest since December 1981. Inflation in the U.S. is expected to remain elevated in the near-term. Initially supply chains struggled to keep up with renewed demand as Covid restrictions and lockdowns eased. Now with Russia’s invasion of Ukraine, we have yet another factor contributing to the inflation narrative. Economies across the globe have begun to reduce, in some cases eliminate, their consumption of Russian oil and gas, unfortunately this is only adding to the existing energy crunch. Additionally, food and fertilizer exports from Ukraine and Russia have practically seized, leading to a sharp increase in food costs. The Food and Agriculture Organization reported a 13% increase for the month of March to an all-time high for world food prices. However, there is a large gap between near-term and long-term inflation expectations, with inflation expected to moderate longer-term (pending continued uncertainty around time frame of the impacts from global conflict and the future of the pandemic).
When we think about bonds, we tend to think this is the safe side of our portfolio. However, for the two-year period ending in March of 2022, bonds averaged -1.8% annually. At only two other points in time since 1926, did bonds perform worse, March of 1980 and August of 1981. However, the following 24 months after those times in the 80’s, bonds performed 11.4% and 23.0% respectively on an annualized basis. Certainly, the FED raising interest rates is putting a short-term strain on bonds. Raising rates also benefits bond investors in that it sets up returns for bonds to be higher going forward. Just looking at the rates compared to a year ago, we can now get a 2-year treasury with a 2.50% interest rate vs 0.15% just 12 months earlier.
With all the negative headlines in the recent months, we still believe bonds play a critical role in portfolio diversification to control volatility. As always, we recommend investors maintain a portfolio anchored by reasonable long-term return expectations with diversification across assets that may benefit from a variety of macro-economic conditions.
Please let us know if you would like to discuss current market conditions, review your portfolio or if there is anything else we can do to serve you.
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