Inflation and war delivered a one-two punch to investment markets in the first quarter of 2022. Despite a partial recovery in the stock market from lows at the start of the Ukraine War, investment accounts declined by mid-single digits on average. The bond market was spooked by the perception that rising inflation may not be transitory and interest rates will have to adjust higher for longer. Good news about the COVID-19 pandemic was overshadowed by Russia’s aggression and the rising cost of traditional energy sources that impact the prices of everything we consume.
If you have filled your oil tank or bought groceries recently, you have felt the impact of inflation on your purchasing power. After three decades of annual inflation averaging around 2%, the inflation rate has increased to more than 7% over the past 12 months. While supply chain issues and a tight labor market are factors, higher energy prices have been the driving force behind the surge in inflation. Despite increases in alternative energy production, restrictions on the distribution and production of fossil fuels have reduced the supply of oil at the same time demand for oil has increased as the world recovers from the COVID-19 pandemic.
Higher inflation has had an impact on US household budgets, and it also has led to losses in the Bond Market. After a 40-year bull market for Bonds, the Barclays Aggregate Bond Index declined by 6% in the 1st quarter of 2022. In recent years, the real rate of return (current interest rate less the rate of inflation) of the 10-year US Treasury Note has been close to 0%. With the spike in inflation, the real rate of return has moved into negative territory, meaning bond investors are losing purchasing power to inflation.
The US Federal Reserve Bank has pledged to aggressively fight inflation by raising the Federal Funds Rate from around 0% to 2% or higher. While the bond market may have already factored in these anticipated rate hikes, there could be further declines in bond prices in the months ahead. Over time, we anticipate that inflation will drop back toward 2% as energy prices decline and supply chain issues are straightened out.
Energy markets may remain tight until there is some resolution to the war in Ukraine. Despite the war, US economic fundamentals appear to be solid. Job creation has been strong and unemployment claims are near all-time lows. While many families continue to struggle, US household balance sheets are solid with high house values and large cash savings. Emerging from pandemic economic restrictions, corporations were able to grow profits by about 25% in 2021. And earnings are projected to grow by low double digits in 2022. Investing in well-managed companies continues to be a prudent investment strategy for the long-term.
This article was authored by Christopher Borden, a financial advisor and Managing Partner located at Canby Financial Advisors, 161 Worcester Road, Framingham, MA 01701. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. He can be reached at 508.598.1082 or firstname.lastname@example.org
Disclosure: Certain sections of this commentary contain forward-looking statements based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets. Investments are subject to risk, including the loss of principal. Because investment return and principal value fluctuate, shares may be worth more or less than their original value. Some investments are not suitable for all investors, and there is no guarantee that any investing goal will be met. This material is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Talk to your financial advisor before making any investing decisions.
The Bloomberg US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market.
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