March Private Client Letter

With geopolitical tensions and the war in Europe dominating our headlines, the two-year anniversary of the S&P 500’s pre-COVID market peak went largely unnoticed.   Just over a month after the peak, the S&P 500 had plummeted by more than 30% before beginning an epic rally of 114%.  While it is now hard to imagine a world without COVID, it is easy to see that COVID has forever changed many aspects of our lives.

With the dramatic decline in Omicron data, most states and local authorities are now moving swiftly to reduce or eliminate COVID related restrictions.  The U.S. economy is still far from being fully “re-opened”, but with a bit of luck this most recent shift towards normalcy is here to stay.

COVID produced massive disruptions to the broader economy.  The government’s crisis response focused on pumping massive amounts of liquidity into the system and the M-2 money supply surged an unprecedented 40%.  Consumers flush with cash and nowhere to go triggered a colossal spike in demand for material goods.  At the same time, producers were unable to meet increased demand because they couldn’t get workers into their plants or on their trucks to deliver the goods.

All of this has produced a surge in inflation levels not seen in over 40 years.  In a remarkably short period of time, the Fed has moved from an extraordinarily accommodative posture to one that calls for a rapid succession of tightening measures.  This shift appears to have caught many market participants by surprise.     

Just as markets were adjusting to this new monetary policy reality, war broke out in Europe with Russia’s invasion of Ukraine.  It may be the shortest month of the year, but February had no shortage of major events driving market performance.  Between earnings season, the FOMC, and war in Ukraine, markets jerked around all over the place and ultimately finished the month lower.

Not surprisingly, investors are feeling the stress.  Investor sentiment has cratered and is now worse than almost EVER.  If you are feeling like the pace of volatility and change are accelerating, it isn’t your imagination.  As information becomes more widely available and the flow more frictionless, trends that once took months to play out now take only weeks or days

So where does this leave us as a new month begins?  Inflation remains the most significant economic story for 2022.  We have long believed that U.S. monetary policy is significantly behind where it needs to be relative to inflation.  The February CPI data will be released on March 10th and we expect the numbers will continue to reflect very high levels of inflation.  Accordingly, we believe the Fed will move to raise the Fed Funds rate when they meet on March 16.  The question will be is the increase 25 basis points, or 50 basis points.

As for the geopolitical tensions involving Russia and Ukraine, there are several encouraging developments that should be acknowledged.  The people of Ukraine have proven to be remarkably resilient in the face of Russian aggression.  NATO has shown great unity and the sanctions against Russia have been meaningful.  New sanctions seem to be announced daily, just as additional aid is pledged to the people of Ukraine. 

Unfortunately, the realities of power and war must also be considered.  Russia’s military power is far greater than that of Ukraine, even as the bravery of the Ukrainian people is second to none.  President Putin has painted himself into a corner and he will likely decide that his only path forward be to bring overwhelming devastation to his invasion strategy.  Accordingly, it should be expected that Putin will push harder and create far more destruction in the days and weeks ahead.  

Were it not for the commotion caused by the war in Ukraine, we would be focused on an economy that was showing continued strength.  Statistics involving corporate earnings, leading indicators, retail sales, and housing starts all point to economic growth – even as the pace of growth naturally slows from the initial post-COVID surge.  In other words, the fundamentals of our economy are currently quite good.

To be clear, the solemnity of war and the human suffering it causes is very much on our minds as we work to understand and process the news reports.  While the humanitarian tragedy occurring in Ukraine weighs heavily on us personally, our professional responsibility is to protect our client assets and advance strategies that will generate desired outcomes; whatever the challenges may be. 

As you might imagine, asserting pragmatic disciplines involving money and wealth can be quite stressful at a time of such great human sorrow and pain.  Still, this is what we are called to do.

The pressing question from an investment point of view is, will the war in Ukraine reverse or dimmish the positive economic trends in the U.S.?    After studying this question carefully, we conclude that the war will not have a major impact on our economy.  We will likely see higher energy prices and additional small-scale supply chain disruptions, but we do not believe the conflict in Europe will slow activity to the point of triggering a recession.  The U.S. economy has reasonable momentum and does not have a significant degree of direct exposure to eastern Europe. 

Additionally, the current geopolitical pressures could slow the Fed’s plans to tighten monetary policy.  Some have suggested that the silver lining here is that this could effectively lower the risk of a policy mistake wherein the Fed becomes too aggressive, inadvertently choking off economic activity.

Beyond the immediate impact the war in Ukraine has on the U.S. economy, we must contemplate the possibility that the current conflict could escalate into something more incendiary involving NATO nations.  Were this to happen, the U.S. could be drawn into the conflict based on NATO’s Article 5, a key element of the 1949 North Atlantic Treaty.  Also known as the Washington Treaty, Article 5 is based on the principle of collective defense.  It means that an attack on one member of NATO is deemed to be an attack on all.

We have a reasonable degree of confidence currently that this is a low probability scenario.  However, the circumstances are fluid, and the landscape could change at any time.  In times of war, it is reasonable to be concerned about miscalculations and unintended consequences related to the conflict.  We must monitor all developments closely.  Importantly, we are developing a range of contingency strategies should the risk of a larger conflict begin to rise.

Public outrage and demonstrations rejecting Russia’s aggression are intensifying all around the globe.  This gives us hope that the decency of peace-loving people will prevail in the end.  Recent days have reminded us of something we have known all along.  We live in an uncertain and, at times, dangerous world.  Still, we remain resolute in our belief that the world will find its way through this conflict and that our best days are still ahead. 

Should you have any questions or concerns, please reach out to us.  Sometimes a candid conversation can provide us with the perspectives we need to get through the challenges we face.