It sure seems that way. 2022 has been the Year of the Fed. There is no mistaking that their actions since March– a series of aggressive interest rate hikes – have torpedoed both stock and bond prices and are today’s prime catalysts for volatility in the world of finance.
Following their meeting, which concluded Wednesday afternoon, Chair Jerome Powell announced another rate increase of 0.75%, taking their target Fed funds rate to a range of 3.0% – 3.25%. Beginning in March, the Fed pivoted rapidly and increased rates five times this year. Surprisingly, Wednesday’s “dot-plot” of forecasts by committee members pointed to a higher rate by the end of 2023 – 4.5% – higher than most analysts expected, putting an exclamation point on their determination to snuff out the inflation spark.
The big fuss is, of course, that higher interest rates raise costs for consumers and businesses, putting the brakes on our economy, and risking a slowdown that could tip into a full-blown recession. So why is the Fed pushing us onto such thin ice? Inflation, inflation, inflation. With widespread price pressures not seen since the 1970s, Jerome Powell has been forced to dust off the Paul Volcker playbook and lean into the difficult and unpopular task of halting an inflation locomotive. In doing so, the risk is real that a recession may be part of the cure.
Interest rates are an effective but blunt tool for affecting an economy and – critically – have a lagged impact. Rate hikes today are not felt for months and quarters, meaning the Fed must try to gauge when to begin to slow or halt their hikes – likely before clear data suggests otherwise. It is part science and part crystal ball. In addition, the Fed must manage expectations, because consumer behavior can be an important driver in the inflation equations. If we think prices will increase, we are likely to buy more now, to stock up, creating more demand than necessary and driving up prices even more. Economists call that an inflationary spiral. So, the Fed’s message is unambiguous – Jerome Powell noted in his after-meeting comments,
“We have got to get inflation behind us. I wish there were a painless way to do that. There isn’t.”
It’s easy to Monday morning quarterback the Fed’s policy U-turn this year. And indeed, the criticism is on target. But give the Fed a bit of grace – hindsight is always 20/20. While clear now they were late to begin to raise rates and slow to halt their stimulative bond purchase programs, the unique and unexpected events of the pandemic, followed by Russia’s unexpected invasion of Ukraine, created a rapidly intensifying (to use a hurricane season analogy) perfect storm environment – one not seen for decades. Stalled supply chains, shortages of raw materials, workers dropping out of the labor market, spiking commodity prices, a shooting war in Europe – you name it, and it seems to have occurred in 2022.
Practically speaking there has been almost no place to hide as both bonds and stocks have been hard-hit this year. It is always tempting to want to sidestep such volatility, and when in the midst of it as we are now, begin to believe that things will never get better. Yet experience and history tell us otherwise. Jason Zweig, the well-known Wall Street Journal columnist well-known for his prescient writing, recently noted that considering adding to beaten-down foreign stocks has merit as an investment idea. Sound crazy? Maybe, but as we see many asset prices re-set to lower levels, their future returns become that much more attractive. It’s counterintuitive but true. Paraphrasing an old adage, we all look for sales in stores and rush to buy, but when financial assets “go on sale” by falling in price, we want nothing to do with them.
Burton Malkiel, the noted author of A Random Walk Down Wall Street, penned a Wall Street Journal editorial piece on Wednesday. It’s worth sharing a quote here emphasizing the importance of staying invested.
“… it isn’t time to give up on equities. Long-term investors saving to build a retirement nest egg need to invest in a portfolio heavily weighted with common stocks. Stocks, representing the ownership of real assets, have been an effective inflation hedge for more than a century and are likely to be so in the future.”
So, what’s the message? One we’ve repeated many times. Well-designed portfolios and financial plans allow one to stay the course through volatility. Many JFS portfolios have emphases on value stocks, stocks of persistently profitable companies, dividend-paying companies, and portfolios that on average have a lower market cap than the broad benchmark indices. In addition, bonds in JFS portfolios have an emphasis on high quality and intermediate duration. In general, these factors have benefited in this difficult environment, lessening the impact of declining prices. And, in a classic case of silver lining, the rise in rates means that at long last, money markets and other shorter-term cash-like instruments can offer yields well above zero, greatly benefiting portfolio yields.
By necessity, a general piece like this must be long on commentary and short on specifics. Please reach out to your JFS team for details on your individualized portfolios and plans. While decidedly uncomfortable, uncertainty is part of long-term investing, and we are gratified to help you navigate the rough waters. On behalf of all my colleagues, thank you for your continued confidence.
