By all measures, April has been an exceedingly difficult month in the economy. It is historically rare for both stocks and bonds to move in the same direction as we have experienced this spring, and the downward trend makes the shift even more apparent. There are a multitude of factors that contribute to the current economic environment. We recognize how distressing these occurrences can be given the magnitude of global issues we have faced in the last two years and continue to face present day. It is our opinion that the items below are directly related to the COVID-19 pandemic and the effects of such we are finding to have an extended shelf life:
Worker shortages: Many near retirement age individuals elected to call it quits rather than transition to a new work model. In addition, the hot economy successfully ate-up any slack in the labor force that previously existed.
Supply chain challenges: With renewed shutdowns in China, and new complications arising from the situation with Russia/Ukraine, we expect continued and increasing shortages of everything that is imported from overseas.
Rising interest rates: The Federal Reserve was forced to lower rates to near-zero in order to spur the economy in the early stages of the pandemic. However, we are now witnessing a reversal as rates return to a more standard level to combat inflation and prevent the economy from overheating. Doing so has already slowed consumer spending across the board, including housing as well as day-to-day purchases. Most importantly, having interest rates back near historic norms allows the Federal Reserve to regain a vital tool—the ability to reduce rates again in the future should another major event occur.
The short-term downside of rising interest rates is downward pressure on bond prices. However, in the long term, this is a positive trend for investors and retirees in particular who will once again be paid appropriately for owning bonds. We anticipate that long term investment grade bonds will yield north of 4% once the rate hikes are finished. However, until this ramp-up cycle is finished, we will see less than favorable valuations on our bond positions. Those who are reinvesting their interest are buying new shares at lower prices and thus are accumulating more shares which will offer significantly more income. Another favorable post-hike opportunity will be the ability to reduce equity exposure if desired since bonds will, for the first time in over a decade, yield a reasonable return. In short, where we recently have had no choice but to let stock positions become a greater portion of portfolios to achieve objectives, we may soon be able to reduce that risk exposure to a more comfortable and conservative allocation. Lowering risk while hitting our target return objectives would be a welcomed change from the position we were forced to move into over the last three years when interest rates paid on these investments went from low to essentially zero.
On top of all this economic unrest, we add an unexpected war to the equation. This threatens all global economies as we struggle with the changes required to work around Russia and the compounding supply chain challenges. The human toll is beyond comprehension and is horrific to watch evolve. The implications of this war are far reaching, and it is safe to say that the daily suffering and loss witnessed via media outlets has caused us all despair as well as concern for what may be next.
Amid all the topics covered above, the United States economy is managing through these challenges as well as can be hoped. We are at full employment and if it weren’t for a lack of workers, corporate earnings and future sentiment would be highly favorable. High long-term inflation could change our economic outcome significantly, but our expectation is that appropriate measures will be taken by the Federal Reserve this year to reduce this concern, with real differences expected in 2023. It is reasonable to expect above average inflation for the next few years, but nowhere near where we are today.
What needs to be done, if anything, to my portfolio considering the current economic climate?
History is our biggest guide for how we should act in times of negative news and a declining market. During the many inflection points over the course of history, in nearly all cases, the best plan of action was to stay the course as we have elected to do year to date. The most recent lesson was March of 2020 when the markets dropped precipitously in the early days of the pandemic. Those who elected to move to the sidelines were left out of the recovery when the markets turned significantly favorable in mid-to-late summer, following the hope for better days ahead. Being long term investors who focus on three-, five-, and ten-year return objectives, we are reluctant to take the chance to miss the recovery via a market timing strategy. That said, we are willing to act when needed to mitigate loss via unusual market movements that we believe have no real explanation or reasonable time of resolution. Those of you who have been with us for decades witnessed significant action from us in the fall of 2008 when we shifted to nearly all cash and a few bonds until we were certain the financial system would survive. Occurrences of that magnitude require action and they may occur again over the long term.
Know that we are monitoring the markets and global situation each day as they evolve. As always, we are here to discuss any concerns or questions you may have, and we greatly appreciate the trust you place in us to navigate challenging times like these.
We wish you a nice spring and a relaxing summer ahead.
SANFORD ADVISORY SERVICES, LLC
● Todd Sanford, CFP® ● Scott Williams, CFP®
● Brent Kerstetter, MBA, CFP®
● Nick Bond, MBA, CFP® ● Elizabeth Yunker
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