Market Update


The stock market had a rocky start early in the new year, but after declining 13%, the S&P 500 recovered some of the losses in mid-March to finish down 4.6% for the quarter.  The tech heavy Nasdaq Index had an even sharper decline, moving down 20% at the low on March 14, and then rebounding to being off 9% at quarter end.  Small Cap stocks in the Russell 2000 index fell 7.5%, while International Stocks in the MSCI Index were off 5.8%. The Communications and Technology sectors had the largest negative impact being down10% and 7% respectively, while the Energy sector had a whopping 39% gain.

Bond yields took a turn upward with increases across the maturity spectrum.  The 30-year Treasury-bond yield increased ½ percent to 2.45%, while the 2-year yield increased from 0.75% at the start of the year to finish at nearly the same yield as the 10-year note at 2.35%.

Early in the new year, with inflation running at a 40-year high, the Fed signaled it would be more aggressive than previously expected in raising rates.  This set the course for the markets decline. The eventual Russian invasion of Ukraine in February added to the concern that was already building, and stocks fell sharply.

We expected a move up in interest rates due to rising inflation would have the biggest impact on the technology sector. As mentioned last quarter, higher valuation tech stocks have benefited over the years in a declining rate environment, but would be most vulnerable to a correction in a rising rate environment. The largest tech companies also have a disproportionate weight in the S&P 500, hence the likelihood of a down market.  But even with an overall market decline, dividend paying stocks and “value” stocks should hold up much better and help offset the potential correction from “growth” stocks.

The war in Ukraine complicates our forecast.  Headlines on progress for peace make the market rally, but we have already seen that reverse on days when the optimism fades and the battles continue.  In January, we expected the supply shocks to be worked out of the system over the course of the year.  However, the war brings new supply shocks and uncertainty around rare metals, pig iron for steel making, nickel, neon gas, fertilizer, wheat, and other important commodities.

Procurement of these materials will shift towards countries that may be able to supplement both the shortages from Ukraine, and the restrictions due to sanctions in Russia.  Canada will likely take on an expanded role in fulfilling some of these commodity shortages, as will mineral rich Australia and countries in South America. Canada is a source for rare metals, and is also one of the largest producers of fertilizers. As sanctions remain on Russia, over time we expect their trading ties with China will expand, while Canadian commodity exports may shift partially away from China and serve as an expanded source to Europe and the rest of the world.

While an alternative supply of the materials may be available in other countries, likely it will be at higher prices, or require a longer lead time before it is available.  The U.S. for example also has rare metals, but it would take several years and government involvement to bring back the mining operations. The longer the war goes on the greater an effect the supply shock will have on many parts of the world.

In a sea of concern and uncertainty, the economic growth in the U.S. provides some balance of optimism. GDP in the U.S. is still at above average levels with the economy re-opening and the remnants of past stimulus money continuing to fuel the recovery.  Keeping the ball rolling is our very low unemployment rate at 3.6%, which allows further opportunity for those seeking work. In decades past, a 6% unemployment rate was considered full employment. There are still more job openings than there are available workers. Paychecks have replaced stimulus checks, and have also greatly benefitted the Treasury Department.  Tax receipts are at an all-time high. Last year’s record collection of $4 trillion is expected to be maintained this year, and could be put to good use paring down our debt.

Tempering our enthusiasm is the Federal Reserve Bank indicating six additional rate increases this year.  After raising the Federal Funds rate 0.25% at their March meeting, they announced expectations for larger increases at their future meetings.  These increases will impact consumer demand, raising costs and reducing purchasing power.  But it will not have an impact on the price increases from supply shock shortages that are beyond the Fed’s control.  On top of the energy price increases impacting the consumers pocketbook, interest rate hikes will increase mortgage rates and the cost of borrowing.  We expect the Fed will alter or moderate their rate hike plans if the economy slows down too quickly.

With that backdrop, we believe many of the economic sectors can still thrive this year, especially energy, materials, healthcare, financials, and industrials. We will tread cautiously and be more selective in the consumer discretionary and technology sectors. In fixed income (bonds), we will maintain our shorter-term duration.