Quarterly Review Q-1 2022
April 14, 2022 – Q1 2022 marks President Joe Biden’s first full year in office. Q1 2022 under the Biden Administration saw the economy continue to recover amidst a backdrop of increasing vaccination rates, consumer spending, a strong labor market, supply chain constraints, and a tapering of the Covid variant, Omicron. On 1/27/2022 the U.S. Bureau of Economic Analysis released the Q4 2021 GDP report, and it was the strongest GDP report since October of 1984. GDP during the fourth quarter of 2021 grew at 5.53% from the same quarter 1-year ago, notching the strongest economic growth rate measured since the Reagan era four decades ago.
As U.S. consumers continue to feel the pinch of rising costs on everything from food, gasoline, apparel, home furnishings, and travel, inflation measured by the CPI – All Items increased 7.5% in January to a 4-decade high of 7.9% (shown in the chart below) in February 2022 from periods one year prior. Record inflation has brought with it market volatility and geopolitical instability that we have not experienced in 2-years, since the Covid crash. Even the Federal Reserve’s preferred measure of inflation, Core PCE, hit a 38-year high of 5.21% in January as ongoing supply constraints and strong consumer demand continue to drive pricing pressures.
Higher energy costs from many sources drove the 4-decade high CPI All Items increase along with used automobiles, lodging, furniture, and airfares rounding out the other top contributing categories.
As the January record CPI and PCE reads, Russia’s invasion of Ukraine coupled with the U.S. banning the importation of the Russian crude oil, has propelled WTI Crude Oil prices to record highs not seen since prior to the Great Recession when WTI reached over $130 per barrel in June 2008.
Consumer Price Index All Items (CPI) – Top 10 Contributing Categories for February 2022:
- Used Cars and Trucks – Up 41.2% in February from one year ago.
- Gasoline – Up 38% in February from one year ago.
- Lodging – Up 25.1% in February from one year ago.
- Piped Utility Gas – Up 23.8% in February from one year ago.
- Lodging – Up 38% in February from one year ago.
- Furniture and Bedding – Up 17.1% in February from one year ago.
- Airfares – Up 12.7% in February from one year ago.
- New Vehicles – Up 12.4% in February from one year ago.
- Major Appliances – Up 11.1% in February from one year ago.
- Groceries – Up 8.6% in February from one year ago.
Housing rents did not make the top 10 contribution list but their impact on embedding inflation long-term cannot be overlooked. Rents increased 4.2% in February from one year prior. Since housing rents make up about 1/3 of the total CPI inflation measure, rents could keep inflation elevated even if the increases in other categories begin to show signs of easing.
On Wednesday, March 16, 2022, the Federal Reserve began its rate tightening cycle with a 25 bps increase in the Federal Funds Rate. The Fed’s move was embraced by investors as a sign of confidence in the U.S. economy and sets the stage for a 50 bps increase in the Federal Funds Rate at the May Federal Open Market Committee meeting. The FOMC has also informally agreed to lower its $8.9 trillion in assets by a maximum of $60 billion in Treasuries and $35 billion in mortgage-backed securities each month.
Our systems and procedures remain the same and the portfolio was adjusted throughout the quarter per our portfolio construction process.
In summary, our process blends two schools of thought:
One is what we call Focused Tactical Allocation (FTA) utilizing ETFs, and the other is a focused individual stock strategy we call Focused Strategies. The result is a dynamic, global, all cap, go anywhere suite of portfolios built for all market conditions.
The blended portfolios look for companies that have had strong historical performance and continue to have prospects for sustainable performance in several key value drivers, i.e., return on invested capital, growth, cash flows, and valuations. In addition to fundamental analysis, technical analysis is used to help identify price momentum as well as aid in execution decisions. At any given time, the portfolio strategies may contain securities in various sectors, or they may contain concentrated sector allocations as well as various or concentrated market capitalizations. Although most portfolios are tactically responsive to immediate market movements and trends, we deploy strategic overlays and trades at the end of each month and on a lagged quarterly basis.
During the quarter, we rebalanced the portfolios and continued to maintain limited exposure to high beta names, accompanied by negative earnings and negative earnings revisions. We shifted to a neutral outlook for the large-cap technology names in the portfolios as much of the anticipated move in interest rates has already been priced in by investors.
The increase in inflationary pressures and the Russian military offensive in Ukraine brought bearish technical signals throughout the quarter. As a result, we increased our cash position from the beginning of the quarter and shorted both equities and bonds in some of our strategies in hopes that we were positioned to take advantage of any short-term weakness in the market given the backdrop of strength and liquidity in the broader U.S. economy.
Overall, we believe the continuation of a change in consumer spending habits from goods to services will continue to broaden the recovery through Q3 of 2022. We have extended our outlook on the broadening of the recovery through Q3 of 2022 largely due to the temporary shock we experienced from the Russian invasion of Ukraine. We expect the stock market to continue its sideways to upward momentum until U.S. economic growth expectations begin to taper or we begin seeing more evidence that the Federal Reserve is not able to bring persistent levels of high inflation to a ‘soft landing’. Any perceived reduction in the U.S. economic growth forecast will be met with a broader PE multiple contractions as economic models are revised downward to reflect slower growth expectations.
The largest risk facing the economy remains a policy misstep by the Federal Reserve in their anticipation of inflation. Another large risk is that consumers begin reducing consumption in response to high levels of longer-term inflation.
We will continue to seek out risks and opportunities by continually reevaluating our stance on all monetary and fiscal policies, inflation, interest rates, corporate margins and earnings, labor force participation, supply chain, geopolitical/China/Russia, unemployment, and regional/national gauges of manufacturing and service level activities.
As we have been communicating throughout the quarter, investors have been put in between a rock and a hard spot with the battle of risk vs inflation. To fight inflation, risk-on assets are required, and to fight volatility (risk), risk-off assets are required. So as inflation numbers continue to persist, and geopolitical events continue to unfold, investors will need to find patience and balance in their portfolios and financial plan.
Joe Maas, CIO | CFA, CFP®, ChFC, CLU®, MSFS, CVA, ABAR, CM&AA, CCIM
David Stryzewski, CEO | CSA, NSSA
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