Economic Commentary and Investment Update

In 2022, the war in Ukraine and resulting sanctions, COVID supply chain shocks, and a re-ordering of global trade have leveled a solid bodycheck on the US and global economies. Even the strongest skater is likely to wobble under such circumstances.

We’ll highlight a few themes which have occupied and at times confounded investors in the stock and bond markets both:

Inflation

For more than a decade, inflation had run below the Federal Reserve’s target. Now, of course, it is running well over. Below are just a few of the contributing causes:

• Wage pressures resulting from two job openings nationally for every job seeker
• Commodity price increases, notably oil but including various other fundamental items such as food and housing as well as the ingredients for many consumer and industrial products. Retail is now among the latest sectors of the economy to feel the pain of increasing transportation and labor costs.

The Fed

The central bank has the very unenviable job of trying to quickly steer the economy from overheating, but not so sharply as to put it in reverse, i.e. into recession. It’s like driving a car whose speed is fixed and whose steering wheel has a pronounced lag. It is a particularly challenging assignment, thankfully entrusted to a very capable central bank.

Here are some highlights of its strategy:

• Interest rate hiking, beginning with May’s half point rise in the benchmark federal funds rate.
• Passive balance sheet reduction, also beginning in May. Translation: starting to shrink the Fed’s mammoth holdings of Treasury and mortgage securities passively–that is, by allowing bonds to mature without reinvesting the proceeds into new securities rather than by selling them in the open market. (Remember, we’re trying not to oversteer.)

These two steps represent the Fed’s attempt to implement a shift in monetary policy which is effective in moderating costs, but not so effective as to stall economic growth.

Investments

Through May 20, 2022, the broad US stock market (as measured by the Vanguard Total Stock Market ETF) has declined by 19.1% year to date. Meanwhile, the broad US bond market (as measured by the iShares Core US Aggregate Bond ETF) is down 9.6%. It’s uncommon for both these broad measures to suffer substantial losses simultaneously. But you didn’t need us to tell you that (once again) this year has been unusual.

One of the brighter stock market sectors: Value stocks. We’ve intentionally supplemented our participation to compensate for the tech-tilting of the overall market.

What’s hurting bonds?

• The bad: higher yields (= lower prices on existing bonds). It’s very unusual for bonds to fall two years in a row. Nonetheless, that’s how 2021-2022 is shaping up so far.
• The good: higher yields (= higher interest rates from here forward on the bonds you own). Bonds continue to serve as a potential counterweight to the risks of the stock market.

We continue to diversify broadly, maintaining market-weight asset allocations, including demonstrating the discipline to buy more undervalued global asset classes in equities and bonds as prices of specific sectors become more attractive.

Rebalancing & Tax-Loss Harvesting

Recently we’ve taken advantage of favorable conditions to re-center our clients’ account balances between their various types of stocks and bonds. This rebalancing corrects for the natural divergences in returns which good investment diversification produces. We have trimmed some positions, adding slightly to others. These modest adjustments re-align our clients’ asset allocations to their target percentages. Our clients know that maintaining their intended risk profile is both prudent and strategic in navigating towards their long-term goals.

We have also just taken the opportunity to soften our clients’ tax bills next spring by harvesting losses in taxable accounts. This “tax-loss harvesting” represents a chance for investors to extract some financial benefit even from declining investments. See our recent blog post “When Life Gives You Lemons” for more on this topic:

When Life Gives You Lemons…

We are ever mindful of the hallmarks of great investing, several of which will serve us all well now: discipline, humility, patience, and courage. We will continue to employ the perspective that our years have taught us, learning and adjusting, as well as maintaining steadiness and balance. We are sincerely grateful for the faith our clients place in us.