The Federal Reserve hiked interest rates for the first time since 2018 in Q1. After their March meeting, committee members forecasted a year-end Federal Funds rate of 1.90%, while the market is pricing in the level by year end to be 2.50% to 2.75%. It is probable that at the next FOMC meeting (May) the committee raises the Fed Funds rate by 0.50%, a move not seen since 2000, with a further increase of 0.25% or 0.50% at the June meeting.
Global central banks, aside from Japan, are all moving in the same direction, albeit on slightly different timelines. We continue to expect elevated volatility as the market sorts out this historic level of tightening.
For those interested in better understanding the interest rate and its effects on the market, be sure to read our recent commentary about this subject.
Investment Outlook and Strategy
The main concerns of investors are the economy (inflation, interest rates, the Fed), the impact from a lingering pandemic, and geo-political issues led by the brutal Russian power grab with Ukraine. Related comments follow.
When COVID shocked world economies two years ago, the support provided by the Fed was engineered to steer global economies away from the abyss. With the recovery now well into its second year, and with inflation rates rising beyond acceptable levels, continued Fed support may cause more harm (inflation) than good, hence Fed moves to be less accommodative and change in the direction of becoming restrictive.
Recent years of zero or negative interest rates were, in our view, indicative of an economy and financial system that is abnormally maligned which no longer applies. To date, the Fed has only increased short-term interest rates by a quarter of one percent, yet investors have sharply raised market interest rates to much higher levels. Our point is that Fed comments have resulted in the market pricing in higher interest rates while Fed actions have been minimal. Economists and investors tend to extrapolate rate increases, and yet, could it be that the Fed will not need to raise rates as much as expected if the market does its bidding for them?
Though COVID and its variations continue to impact people around the globe, we sense the pandemic has evolved into an endemic which, from an economic and investment perspective, will be less of a factor in portfolio management.
Of all the alternatives for resolving the Russian-Ukraine ongoing tragedy, there are no good outcomes—just less bad options. We would not be surprised that a negotiated resolution is crafted which allows Ukraine to remain independent and become a member of the European Union while Russia takes control of certain targeted areas. A face-saving agreement may be required by Putin at a cost of leaving Russia and Putin as isolated pariahs.
Only time will tell whether we are at the start of a bear market, a pause in a continuing bull market, or something in between. Our guesstimate is the last option: the long upward trending bull market will continue with periodic dips and corrections. This is based on the view that bear markets normally go together with recessions, which we find unlikely in the next year or so, and we look for corporate profits that exceed expectations. That said, the overall market may struggle as stock multiples adjust to higher interest rates.
As this repricing of assets runs its course, selective stock picking and bond portfolio management will prove beneficial. We have this background in mind as we monitor all existing positions and others with a favorable risk/reward relationship.
In fixed income, we have been managing portfolios to minimize the impact from rising interest rates, and to opportunistically buy bonds as interest rates normalize to higher levels, thereby increasing portfolio income. In equity portfolios we will maintain positions in well-managed companies that are well positioned to navigate developments in an evolving landscape. This includes stocks of attractive companies with stock prices that have declined and present better entry prices and value.
Bull markets are known to climb Walls of Worry and there certainly is no shortage of worries at present. To benefit from the long-term growth and returns that stock investments provide, investors need to endure periodic declines and stay the course through its gyrations. As always, please contact us if we may be of assistance.