Q1 growth slowed, the Fed is trying to fight inflation, but global economic growth remains positive.
These are the times that try investors’ souls. There’s certainly no lack of dark clouds on the horizon, and seemingly all around us at the moment. However, as difficult as it may be to look past the economic and geopolitical crises, that’s precisely what a long-term investment perspective requires.
Global economic growth slowed considerably in Q1 with the U.S. economy slipping into negative territory (-1.4%). Major supply shocks (COVID and the war in Europe), combined with years of easy monetary policy, have pushed inflation to its highest level since the early 1980s. Stagflation fears seem to dominate headlines everywhere.
To combat inflation, the U.S. Federal Reserve in March raised the Fed funds rate for the first time since 2018; interest rate markets now predict the Fed will raise the Fed funds rate to nearly 3% by year end (up from its current 0.38%). However, given the current state of the yield curve (it’s flat to slightly inverted), the Fed runs the very real risk of pushing the U.S. economy into recession in its mission to bring down inflation. Subsequently, there’s a very real prospect of a major Fed “policy error”, i.e., raising rates too far, too fast or not fast enough, far enough. It’s a difficult balancing act and the prospect of a “hard landing” (read: recession) seems more likely than not.
Further, this week’s FOMC meeting (the policy committee that sets interest rates) will provide insight into Fed’s new inflation-fighting bona fides; several weeks ago Fed Chairman Jerome Powell telegraphed a 50 basis point hike at their May meeting. Whether they do so, especially in light of Q1’s ugly -1.4% GDP growth rate, remains to be seen. That said, we should keep in mind that the Fed’s two mandates don’t say anything about maintaining positive economic growth—they focus explicitly on (1) price stability and (2) maximizing employment. The latter isn’t an issue currently; the former obviously is.
As a result of the challenging macroeconomic environment, most asset classes dipped further into correction territory last month. U.S. equity markets lead the way the way, with the Russell 3000 returning -9% for the month versus -5.5% for emerging markets and -6.5% for developed non-U.S. markets. Within all markets, value bested growth and multifactor strategies continue to outperform (relative to core) on a relative basis YTD through April 30.
In the fixed income arena, the Bloomberg US Aggregate and Global Aggregate bond indices returned -3.8% and -5.5%, respectively. Despite a difficult month for virtually all asset classes, it was nevertheless a month where diversification beyond just U.S. equities paid off on a significant (if relative) basis.
All difficult markets have a beginning, a middle, and an end. This one too shall pass. But simply knowing the storm will end doesn’t necessarily make it any easier to weather. To do so, here are a few things investors would be wise to consider.
Sources: JP Morgan Weekly Market Recap, May 2, 2022. JP Morgan Guide to the Markets, As of April 30, 2022.
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