Is this Contraction or Capitulation?


By Maurice Stouse, Financial Advisor and Branch Manager

The financial media are replete with reports that the markets in 2022 are off to one of their worst halves in recorded history. The stock market – the worst since 1970. The bond market, the worst ever. That begs the question, is the worst over or is the worst yet to come? We think that a lot if not all of this is in response to what the current environment is and is also part of the journey for long term investors. We encourage investors and clients to not try and predict where things (or the markets) might be going in the short run and instead to focus on what strategies and allocations meet their objectives, time frame and risk tolerance. Nonetheless, some of the media leave people wondering if things are contracting or if the sky is finally falling. We think it is a contraction and that the sky is not falling. It’s not different this time and the past keeps happening in the present.

What then is driving the contraction?
The current drivers are inflation (caused by very expansive monetary policy and the pandemic), the fall for housing from rising rates (more than 2.5 times higher to borrow now than in January), the ongoing crisis in Ukraine, and stubborn supply chain issues. Wages have risen (although up over 5% they still are not matching inflation) and that adds to production costs. What is all adding up to the markets – traditionally a forward predictor of the economy – is that stocks and bonds were overvalued relative to where we were headed, and the sell offs began. What accelerated that was the Federal Reserve raising its short term rate and, we think most importantly stopping the buying of bonds and hence shrinking the amount of money or liquidity that was out there.

Elevated risk and or speculative investments (like cryptocurrency) have been significantly impacted on the negative side. Add to that many technology stocks (over 25% of the market’s value is in technology stocks) may have little to no earnings and investors bought those stocks in hopes for future growth vs current earnings. The fallout has been brutal for the tech heavy NASDAQ.

The Business Cycle Considerations
So, while this may help explain a lot, what else might be important to consider? We suggest that investors look at the business cycle. In a recent issue of Utility Forecaster, they point out that there are four phases: early, mid, late and recession. They suggest that the current environment of rising rates, inflation, higher energy prices all point to late or recession. That makes a lot of sense to us and therefore we think the current environment (while the inputs may look different) is no different from past environments and that the past keeps happening. We think investors should take that into consideration at times like these.

Lastly, the energy scenario
Raymond James projects that a barrel of oil will be selling around $90 a year from now and $80 two years from now. In either scenario that is well above the approximate cost of less than $40 a barrel for most domestic producers. With world demand restored and growing, the legacy energy sector has continued to show strong revenues and earnings. That is for exploration and production companies. Also consider that refineries have less capacity (and little to none planned) and therefore the competition for a gallon of gas remains high and keeps gas prices high. Despite that, inflation, ex food and energy, has declined to approximately 6% from 6.2% as recently reported.

These are the times that test investors’ will, confidence and patience. We urge investors to reflect on the past, think about the present and continue to prepare for the future. There is a book out on the life of former Secretary of the Treasury and of State James Baker, (The Man Who Ran Washington by Peter Baker and Susan Glasser) and we reflect on a quote on something he learned early in life which he applied throughout his career in law and government (the five Ps): Prior Preparation Prevents Poor Performance.

The First Wealth Management is located at First Florida Bank, a division of The First Bank, 2000 98 Palms Blvd, Destin, FL 32541. Branch offices in Niceville, Mary Esther, Miramar Beach, Freeport, and Panama City. Phone 850.654.8122.

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Views expressed are the current opinion of the author, not necessarily those of RJFS or Raymond James, and are subject to change without notice. Information provided is general in nature and is not a complete statement of all information necessary for making an investment decision and is not a recommendation or a solicitation to buy or sell any security. Past performance is not indicative of future results.

Investing involves risk and you may incur a profit or loss regardless of strategy selected, including diversification and asset allocation. Investors should consult their investment professional prior to making an investment decision.

Investing in oil involves special risks, including the potential adverse effects of state and federal regulation and may not be suitable for all investors.

There is an inverse relationship between interest rate movements and fixed income prices. When interest rates rise, fixed income prices fall and when interest rates fall, fixed income prices rise.

Bitcoin and other cryptocurrency issuers are not registered with the SEC, and the Bitcoin marketplace is currently unregulated. Bitcoin and other cryptocurrencies are a very speculative investment and involve a high degree of risk.

Investors should consider the investment objectives, risks, charges, and expenses of an exchange traded fund carefully before investing. The prospectus contains this and other information and should be read carefully before investing. The prospectus is available from your investment professional. The companies engaged in the communications and technology industries are subject to fierce competition and their products and services may be subject to rapid obsolescence. Investing in the energy sector involves special risks, including the potential adverse effects of state and federal regulation and may not be suitable for all investors.