MARKET WATCH
Readjustment is probably one of the most appropriate words I can think of to sum up the myriad of thoughts which deluge my mind as I contemplate the first quarter of 2022. Since ending the year with double digit returns and close to record territory, the stock market indexes have been whipsawed for most of the first quarter, logging their first 10% correction since climbing out of the pandemic’s bear market, and they are still down year to date. Besides having to readjust to a return to more normal market conditions where corrections, which are good for the market, do happen, investors have many other issues on which to focus going forward.
However, the markets are not the only place readjustments are happening on what seems like a daily basis. Just visit the grocery store, a real estate office, a mortgage company, an appliance store, a used car dealership or a local restaurant and you just can’t help but notice that prices have been upwardly readjusted. In fact, inflation, a term which had been all but deleted from our vocabulary, has made a roaring comeback over the last twelve months or so, and brought back with it some terms associated with the 1970’s like stagflation and energy crisis. While it is too soon to say whether stagflation will become a reality, we are caught up in a bit of an energy crisis already.
Since I am always an optimist, my hope is the crisis we are experiencing here in the United States, which is at least partially self-inflicted, will lead to a less naive energy policy where the current administration doesn’t demonize hydrocarbons while continuing to move to a renewable energy future. It is fool-hearty and dangerous to attempt to move away from oil and gas without contingency plans, a lesson Germany has learned this year.
While no official change in US policy has been indicated since Russia invaded Ukraine, gasoline has breached the $4 a gallon mark, a point at which Americans get anxious and angry. In remarks on March 31st President Biden said he plans to tap the Strategic Petroleum Reserve (SPR) for 180 million barrels of oil. Mr. Biden said,” The action I’m calling for will make a difference over time, but the truth is it takes months, not days, to increase production. This is a wartime bridge to increase oil supply until production ramps up later this year”. I am sure the oil and gas producers in our country are going to want some assurances before “ramping up production”.
On February 24, 2021, according to the New York Times, the President said, “It was his plan to make the Saudis pay the price and make them in fact the pariah that they are” speaking about the crown prince’s role in the killing of Jamal Khashoggi. Furthermore, he said, “There is very little socially redeeming value in the present government in Saudi Arabia.” Is it any wonder the Saudis are a bit reluctant to increase oil production when the President comes calling?
The US used 19.78 million barrels of oil a day in 2021, which annually is about 7.22 billion barrels. So, the reality of the drawdown from the SPR is that 180 million barrels of oil equals just less than 10 days of oil consumption in the US. Reducing our carbon footprint as a nation is a worthwhile goal, but for the next 50 to 100 years oil and gas are going to be necessary.
As for the stock market indexes, the DJIA* ended the first quarter at 34,678.35 down 4.6% YTD while the S&P 500* dropped 4.9% YTD and closed at 4,530.41. The worst performing index was the NASDAQ which finished at 14,220.52 for a decline of 9.1% YTD.
The Federal Reserve raised interest rates in March by 25 basis points to .25%-.50% and has promised to continue to raise them as conditions warrant. The Bureau of Labor and Statistics reported March nonfarm payrolls up 431,000 and the unemployment rate at 3.6%. The third estimate of Gross Domestic Product (GDP) was released on March 30th and reported the annual rate of growth at 6.9% for the fourth quarter of 2021. For all of 2021, the rate of GDP growth was 5.7%.
So, as we continue our readjustment to changing circumstances, I’m here to discuss any questions or concerns you might have.
Is it spring yet?
INFLATION EXPECTATIONS CONTRIBUTE TO PRICE SPIRALS
Understanding all the various factors affecting the performance of our economy is a daunting task with much disagreement at times. One element in the economic picture on which there is some agreement is inflation. Most economists and people in general agree that a little inflation is ok and in fact good, hence the Federal Reserve’s goal of 2% annual inflation. Most people would also agree that too much inflation is bad for the economy and bad for the wallet.
Expectations concerning inflation are one of the factors that can be the most difficult to control and at the same time the most damaging. Once the specter of rising prices is built into people’s psyche, the expectation that prices will be higher next week than they are today becomes a self-fulfilling prophesy. Higher prices beget concern about higher prices which leads to buying now to avoid higher prices in the future, and the spiral continues to go higher and higher.
This is the reason the Federal Reserve raises short term interest rates which eventually will cause longer term rates to increase. The idea is to make the cost of money more expensive, especially on interest rate sensitive items like houses and automobiles. This can break the inflationary spiral as consumers either can’t get approved for credit or make the decision the price is just too high.
At this point we are not in a situation like the 1970’s and should be able to avoid the damage caused by the expectation of higher prices, but it starts with all of us being aware & vigilant.
UNDERSTANDING THE YIELD CURVE AND ITS RELATIONSHIP TO RECESSION
The change in monetary policy by the Federal Reserve has also begun the discussion of another element of the economic picture, that being the yield curve. The yield curve is a graphic depiction of the relationship between short-term and long-term interest rates. In a healthy economy, interest rates on short-term bonds are less than the interest rates paid on longer-term bonds, because for an investor to lend money to the government for a longer period, the investor expects a higher rate of return. So, going back to math class, graphing a line depicting bond yields going from short-term to long-term would result in a positively sloped line. In other words, a line with an upward trajectory from left to right.
Why is this important? It is important, because there has been talk in the press about the possibility of an inversion of the yield curve, meaning rather than interest rates being lower on the short-term end and higher on the long-term end, the scenario flips and short-term rates are higher than long-term rates. This causes the slope of the graphic depiction of interest rates to have a downward trajectory from left to right, or an inversion.
The most widely reported spread on bond yields associated with the yield curve is the spread between the two-year Treasury note and the ten-year Treasury bond. On Friday, April 1st (and this is no April Fool) the two-year Treasury note closed at a 2.46% yield and the ten-year Treasury bond closed at a 2.38% yield, which created an inversion. By the time you have read this newsletter, there will be more talk of recession since yield curve inversions between the two-year Treasury note and the ten-year Treasury bond have happened in 5 of the last 6 recessions.
However, yield curve inversions can happen without an ensuing recession, so this is not necessarily a dire situation. Since the Federal Reserve began its regime of interest rate increases, which could include a couple of 50 basis point increases in May and June, the short-term or two-year Treasury note investors have priced in possible rate increases which haven’t happened yet, much like investors sometimes bid up the price of an equity investment on a good earnings report, or some other type of good news.
The actual model for understanding the yield curve and its ability to predict recession was developed by Arturo Estrella & Frederic Mishkin, economists with the New York Federal Reserve. In their model, they compared the relationship between the ten-year Treasury bond and the three-month Treasury bill. It can be found in the June 1996 release of Current Issues in Economics and Finance.
As of the April 1st close of the bond market, the yield on the three-month Treasury bill was 0.51%, well below the ten-year Treasury bonds 2.38% yield. The point is there can be an inversion of the yield curve, especially between the two-year Treasury and the ten-year Treasury, without a recession, because this is not the model that predicts a recession. If the three-month Treasury rises above the ten-year Treasury, we might need…. you guessed it…. readjustment!!
For now, the economy is strong, and the Fed is threading the needle.
Have a Happy Easter!!
*The S&P 500, the DJIA, the NASDAQ and others referenced are unmanaged indices that are widely used as indicators of Market Trends. Past Performance does not guarantee future results and the performance of these indices does not reflect the fees and charges associated with investing. It is not possible to invest directly in an index.
*Dollar Cost Averaging through a systematic savings plan is an excellent way to build an account without a sizeable initial investment. Saving a portion of our pay each month is very important. Company sponsored pension plans are one method to save and should be used for retirement. Other systematic investment accounts, such as ROTH IRA’s, Traditional IRA’s, Coverdell Accounts, 529 Plans, Brokerage Accounts and Annuities can also be opened, and debited directly from checking or savings accounts. For more information, just call to set up an appointment. Referrals are always welcome.
John H. Kaighn
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COMPANY INFORMATION
John H. Kaighn offers various products and services under the trade name of Jersey Benefits Advisors.
PO Box 1406
Ocean City, NJ 08270
Phone: (609) 827-0194
Fax: (856) 637-2479
Email: kaighn@jerseybenefits.com
http://jerseybenefits.com
John H. Kaighn is an Investment Advisor Representative & Registered Representative of Royal Alliance Associates, Inc. Securities and Advisory Services are offered through Royal Alliance Associates, Inc. (RAA) Member FINRA & SIPC. RAA is separately owned and other entities and/or marketing names, products or services referenced here are independent of RAA.
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Royal Alliance Associates, Inc. is not affiliated with Jersey Benefits Advisors or Jersey Benefits Group, Inc.
Insurance Services and Third Party Administration offered through Jersey Benefits Group, Inc., a licensed Insurance Agency in the State of New Jersey.
PO Box 1406
Ocean City, NJ 08226
Phone: (609) 827-0194
Fax: (856) 637-2479
Email: kaighn@jerseybenefits.com
http://jerseybenefits.com
All opinions expressed in this newsletter are independent of Royal Alliance Associates, Inc. and solely those of John H. Kaighn and Jersey Benefits Advisors.
