May 2022

In four words: Don’t fight the Fed. It’s nice when the Federal Reserve begins to support the economy and markets after a recession or some other hit like a terrorist attack (2001), financial crisis (2008), or pandemic (2020). However, the reverse is true when the Fed begins to tighten when the economy heats up, and inflation shows up to the party.

After claiming that inflation was transitory for most of last year, the Fed has recently stated that it isn’t, and that’s noticeably clear. And it’s getting worse. Already strained supply chains are now dealing with the commodity supply shocks from the Russia-Ukraine conflict, a spike in oil prices, and supply disruptions from Covid lockdowns in China. Now inflation is moving into services too. Consumers continue to spend, flush with cash from a tight labor market and savings from the pandemic.

It’s a different world. The Federal Reserve has kept rates low so many years, and perhaps we all got used to easy money. That may all have to change now, and the market doesn’t like it. The Fed is much to blame for our current predicament: It waited too long to raise rates. It’s a significant change. Stocks and bonds are falling simultaneously – something that hasn’t happened since 1994. Think of letting air out of a balloon. The Fed raised rates by 50 basis points (one-half percent) last week – the first half-point hike since 2000. And a 75-basis point hike is not out of the question. The market is trying to adjust to the new reality. The S & P 500 index is down over 16% so far this year and has dropped the last five consecutive weeks, and the trend looks like it will continue this week.

Earnings look good, but everyone knows the end game. If the Fed continues to raise rates to fight inflation, the economy will eventually have to slow down. And with that goes jobs, consumer spending, and earnings, i.e., a recession. The market may now be pricing in the very real possibility that the US may enter a recession next year. How high will the Fed have to raise rates? Will it have to raise rates so much that it causes a deep recession? Of course, no one knows, and therein lies the uncertainty. Markets always dislike uncertainty. Stocks may be pricing in the real possibility that the US may enter a recession next year.

Times like these call for patience. And your patience will be rewarded. Diversification is critical as a wide variety of scenarios may play out. The good news is that eventually, uncertainty recedes, and the market settles down. Higher yields will make bonds more attractive and stable. Companies will adjust to the new price regime and move forward.

It may be a rocky summer. Please feel free to contact me if you need any further information.

Sincerely, 
Henry 

Henry Gorecki, CFP® 
HG Wealth Management LLC 
401 N Michigan Ave, Suite 1200
Chicago, IL  60611
312-723-5116