By Maurice Stouse

It has been quite a different year for investors. Investments can be classified in a few main categories:  1) Financial: stocks, bonds or cash; 2) Real: real estate, 3) Alternative: gold, bitcoin, commodities as examples 4) Personal: jewelry or perhaps collectibles.

War, rising interest rates and bond yields and inflation have had a major impact on asset prices. At this writing, stocks are down -10% YTD, bonds are down -10% however cash (based upon yields only) has climbed to approximately .25% from at or near zero at the start of the year. Bitcoin has had an increasing amount of volatility and commodities for the most part have rallied.

What is Driving Volatility?

Uncertainty over the short term has traditionally added a lot to volatility for most asset classes.  While a long-term perspective (in line with an investor’s risk tolerance, investment objective or goal and time frame) offers the best approach, in our opinion, the volatility can lead to a lot of concern for investors.

The big three, with no surprise are 1) the horrific war in Ukraine and the fallout being seeing and yet to be seen 2) Rising rates and the impact to the economy and earnings and 3) inflation (at a four-decade highs).

The war has brought uncertainty to grain supplies, specialty gasses and minerals and metals, oil and gas as well as impacts to world security. It has meant strong short term returns for defense stocks but has added to inflation and overall uncertainty.

Rising rates have continued to impact growth-oriented stocks (technology for example) as well as the current value of bonds. When rates rise that means bond prices have fallen. Rising rates are also impacting the mortgage lending market as long-term mortgage rates crossed 5% for the first time in over a decade.

Inflation has continued to increase with the latest CPI reading of 8.5%. This is a rate not seen in over four decades. That impacts yields, earnings, cost of borrowing and potentially the value of the dollar (although the dollar is  up over 5% YTD).

What Might Bring Inflation Down?

In our view, housing costs could be slowing and the main reason for that is rising mortgage rates. Housing accounts for approximately 40% of CPI. That is not to mean the growth of housing as an investment but rather something called the Owner Equivalent Rent of an owned home. As housing values grew (over 18% in 2021 for example) that had a major impact on CPI.

We now consider this: Mortgage rates have climbed from the low 3s to over 5% in a few short months. The cost to borrow is higher and that cost is starting to squeeze out would be buyers. The Washington Times reported recently that when rates crossed 5%, over 10 million would be homebuyers would be pushed out of the borrowing market. That is because the rates to borrow and or amount they can borrow worked against their ability to quality. We also consider so-called demand destruction: As an asset climbs in cost, demand goes down. The cost to build (materials and labor) as well as inventory are beginning to work against housing prices and that we believe will have a mitigating effect on inflation. We agree with a lot of what we see and hear: Inflation is likely to move to 5% or lower by year’s end and that is mainly due to housing.

The Fed Raising Rates 

We learned at the start of the year that 2022 was the year of “Don’t Fight the Fed”, according to Global X, a provider of exchange traded funds. The action of the Federal Reserve on two main fronts are of importance to investors: 1) raising the Federal Funds rate (currently at .25%) in May as well as perhaps in June, July and at other intervals for the remainder of the year and 2) The Fed’s balance sheet. That has a significant impact on the supply of money or liquidity in the economy. The Fed is yet to start reducing that (it is approaching $9 trillion). We understand the Fed intends to start reducing that in June. Fewer dollars could also have a mitigating effect on inflation as well. We think the balance sheet has a greater impact than raising rates.

Where Might Markets be Headed

Predictions we believe take a back seat to objectives, time frame and risk tolerance. While equities and real estate have historically outperformed most other asset classes as well as inflation, their returns have not been uniform. Timing the markets is not a strategy but time in the markets we think is a strategy. According to Jim Cramer of CNBC, panic is not a strategy either. Expectations and hope have not factored into achieving investment goals or targets either. Timing, conviction, and patience have proven to serve investors well in our view.

According to Ibbotson, Morningstar (data from Raymond James) large cap stocks (which make up 70% of market value) have returned 10.5% from 1926 to 2021. That includes reinvested dividends as opposed to taking those dividends in cash. Government bonds have averaged 5.5%, Treasury bills (close to cash) 3.3% and inflation 2.9%.

Many institutions suggest that investors might anticipate lower returns on equities (stocks) over the next decade. Vanguard (vanguard.com) has its most recent direction that US equities might return just 3.3% over the next decade. They feel, at this point, that global (non USA) equities would fare better at 6.2%. See their website for greater detail.

Valuations are always important for investors to take note of. Most would agree that valuations (costs) of many investments, stocks are high. That means for valuations to come down, stocks would have to continue to sell off or earnings would need to rise. It is important to note, at least at this writing, that US companies continue to report strong earnings and strong earnings growth.

Headwinds and Tailwinds

Goldman Sachs recently commented on inflation’s direction and pointed more toward tailwinds for decreased inflation with three main points: 1) slowing growth of energy costs 2) slowing growth of wage costs (unretirements have been reversing the great resignation with 55+ year olds and hence a greater labor pool, lowering wage pressures) and 3) rising mortgage rates slowing the cost of housing (a major component of CPI as noted earlier).

While the world and the markets are climbing a wall of uncertainty, investors and would-be investors might want to take the time to review and update their goals and strategies. We believe this should be done at least annually and that investments should be reviewed at least quarterly. When goals, time frame or risk tolerance change, then a plan matching those should be developed and implemented.

The First Wealth Management is located at First Florida Bank, a division of The First Bank, 2000 98 Palms Blvd, Destin, FL 32541. Branch offices in Niceville, Mary Esther, Miramar Beach, Freeport, and Panama City. Phone 850.654.8122. 

Raymond James advisors do not offer tax advice. Please see your tax professionals. Email: Maurice.stouse@raymondjames.com.Securities offered through Raymond James Financial Services, Inc. Members FINRA/SIPC, and are not insured by bank insurance, the FDIC, or any other government agency, are not deposits or obligations of the bank, are not guaranteed by the bank, and are subject to risks, including the possible loss of principal. Investment Advisory Services are offered through Raymond James Financial Services Advisors, Inc.

 The First Wealth Management, First Florida Bank, and The First Bank, are not registered broker/dealers and are independent of Raymond James Financial Services.

Views expressed are the current opinion of the author, not necessarily those of RJFS or Raymond James, and are subject to change without notice. Information provided is general in nature and is not a complete statement of all information necessary for making an investment decision and is not a recommendation or a solicitation to buy or sell any security. Past performance is not indicative of future results.

Investing involves risk and you may incur a profit or loss regardless of strategy selected, including diversification and asset allocation. Investors should consult their investment professional prior to making an investment decision.

Investing in oil involves special risks, including the potential adverse effects of state and federal regulation and may not be suitable for all investors. 

There is an inverse relationship between interest rate movements and fixed income prices. Generally, when interest rates rise, fixed income prices fall and when interest rates fall, fixed income prices rise.

Bitcoin and other cryptocurrency issuers are not registered with the SEC, and the Bitcoin marketplace is currently unregulated. Bitcoin and other cryptocurrencies are a very speculative investment and involve a high degree of risk. 

Investors should consider the investment objectives, risks, charges, and expenses of an exchange traded fund carefully before investing. The prospectus contains this and other information and should be read carefully before investing. The prospectus is available from your investment professional. The companies engaged in the communications and technology industries are subject to fierce competition and their products and services may be subject to rapid obsolescence. Investing in the energy sector involves special risks, including the potential adverse effects of state and federal regulation and may not be suitable for all investors.

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