Dear Client :
Returns for the major stock indices and the current bond and money market yields are as follows:
|Dow Jones Industrial Average||-4.56%|
|Fixed Income Yields||1 year||5 year||10 year||30 year|
|Fidelity Government Cash Reserves Money Market Fund||0.01%|
The first quarter of 2022 has been distressing. The news of Russia’s invasion of Ukraine has captured the hearts and minds of so many worldwide as the daily headlines of chaos and suffering are difficult to see, let alone to bear. From a global pandemic to an unprovoked war by a nation with nuclear weapons, investors have had much to consider. Anxiety, unease, and uncertainty have felt commonplace in recent history. As investors, we have to again try to assess the risks to our investment strategies amid the fears and uncertainties. Despite the volatility, the markets have been resilient as they have rallied back significantly for the year. Though we cannot know how the invasion will play out, we can reflect on history, study the investment implications and alternatives, and attempt to mitigate the risks as we understand them.
Russia’s invasion of Ukraine on February 24th was a surprise to some, but not all. The troops and drumbeat to war had been building along the Ukrainian border for months. On the day of the invasion, the Dow Jones Industrial Average dropped 859 points at its intraday low, only to close up 92 points, an intraday reversal of nearly 1,000 points. To date, both the market low (down 11% or 4,000 points) and peak fear were during the first day of the invasion. The markets again quickly processed the news, reacted, and began to look forward. It is often said that war is good for business. We will not try to make that argument here, but upon review of the Cuban Missile Crisis, Vietnam War, Gulf War, Afghanistan War, Iraq War, and Crimean Crisis, all but the Afghanistan War proved to be favorable entry points into the equity markets. Of course, every situation is different; during World War II, the market did not bottom for three years before becoming one of the best opportunities ever to invest in equities.
Like always, history is clear in hindsight, and looking forward is never easy. As is common in the midst of fear, it’s only natural to consider worst-case scenarios. The elephant in the room is the risk of escalation and direct confrontation with Russia, and more specifically the possibility of nuclear war. Again, we certainly cannot know the outcome, but in short order, NATO and the West have united like never before. The 30 NATO countries are ramping up military spending and implementing devastating economic sanctions. Even the forever neutral Switzerland has agreed to adopt all European Union sanctions. At minimum, the Cold War is back, and though Russia has nuclear weapons, they have severely (and perhaps irreparably) damaged their wealth and standing in the world. Despite all the chaos and fear, the US equity markets have remained resilient, and investors seem to be shrugging off the worst-case scenario.
While war and peace can certainly dominate headlines and emotions, it can be difficult to separate and assess risk in a conventional manner. Perhaps the most significant economic effect on our markets is inflation, which was already at 40-year highs before the invasion and now has additional catalysts with numerous international trading bans, including Russian oil, gas, and coal by the US and UK. The bond market has been in steady decline (-10%+) since its peak in August 2020 and is down 6% year to date. The TINA (There Is No Alternative to equities) discussion has become more inescapable with each passing quarter. The real rate of return on bonds continues to make asset allocation a perplexing problem for money managers everywhere. The Federal Reserve, which raised the money supply by 40% in the last two years, has begun raising interest rates and “plans” to put a lid on inflation. The rapid increase in money supply likely helped curtail a deeper recession during COVID, but now the Fed has to attempt to unwind the elevated inflation (easier said than done). Certainly, inflation has many contributing factors, with the increase in money supply being the most significant, and though they cannot know the future either, the Fed projects inflation will come back to more normal levels in 2023.
We continue to believe volatility will be with us in 2022 as we approach the midterm elections, as the Fed raises rates, and the war continues. Our transition to more value-oriented individual stock models has performed relatively well recently as value has outperformed growth across all styles (small, mid, and large-cap stocks). We will continue with the value bent for most of our equity models as the bond market still has unattractive yields and high-growth stocks continue to be too expensive for our taste.
We thank you for your continued confidence in LYNCH & Associates. As always, we welcome you to schedule an appointment to review your financial situation.
Ryan T. Lynch, CFP® ChFC®
Form ADV Parts II & III of the LYNCH & Associates Uniform Application for Investment Advisor Registration and the LYNCH & Associates Code of Ethics is available to all clients at any time. If you would like to receive a copy, please contact Jennifer Farless at (812) 853-0878 or jfarless@LNAonline.com.
Office: 10644 Newburgh Road, Newburgh, IN 47630