As predicted earlier in the year, inflation has become the elephant in the room that absolutely nothing can escape from.
Inflation is draining funds away from consumers in a dramatic fashion. Consumer sentiment is now at its lowest level in years, causing households to slam their wallets shut. Corporate earnings for consumer goods companies are thereby getting slammed, as evident in major missed earnings by Walmart, Target, and Kohl earlier this week. Corporate inventories are now building up, all while companies are still struggling to secure parts for their supply chain.
The primary culprit of inflation seems linked to the Russia - Ukraine conflict. Republicans are sure to use post-covid spending as a reason why inflation has risen to dizzying heights. But the bulk of evidence suggests this is only partially to blame. Japan was the highest spender of covid relief, yet has seen barely a blip in inflation as a result.
Inflation levels around the world are high, but it indeed seems worse in countries directly involved in the Russian - Ukraine conflict. U.S. and E.U. inflation is hovering in the 8 percent range, whereas inflation in China is relatively muted and in Japan and South Korea is rising only 3-4 percent.
Meanwhile, key commodities linked to the Russia - Ukraine war such as oil, gas, wheat, and corn remain elevated. These pressure are likely to persist through the rest of the year, and are likely to lead to dramatic action by central banks around the world to hike rates. Central banks in Eygpt, South Africa, and the Philippines already made large hikes this past week to curb pressures, and this trend will likely continue for the next 6-12 months.
And supply chain woes remain as high as ever, as made clear by the Federal Reserve’s new global supply chain pressure index.
And while Treasury yields lowered slightly this week, yields are still elevated on the year.
In short, what this all means is, with the Russia-Ukraine conflict still raging, and with CPI prints still coming in hot, we see no evidence of market volatility settling down over the short term.
Looking at the market from a pure valuation perspective, we do indeed look like we are approaching a bottom. However, the market has slumped more in times of extreme uncertainty, such as during the covid crisis or in the aftermath of 2008. Given the confluence of factors still facing us, we should expect the market to reach these bottom trenches in the ensuing months. Be prepared.
In fact, as the war and inflation pressures continue, there is increasing evidence that later this year we could expect the following:
a recession. The Fed essentially has no choice but to raise rates when inflation comes in so hot, even if the inflation is caused by supply-side factors. Supply-side inflation can rapidly become embedded into consumer expectations, adding more inflationary fuel to the fire. The Fed is likely to push us into a recession, and we will have no choice but to eat the pain.
a food crisis with the potential to create social instability. With wheat and corn prices rising through the roof, developing countries that are large food importers could see severe food shortages as a result of being priced out of the market. Russia and Ukraine make up half to two-thirds of the cereal imports for many Middle Eastern countries such as Lebanon, Tunisia, Libya, and Egypt. The projected shortage is so severe that many publications are projecting a social stability crisis in these countries. Add on top of that the already volatile climate conditions impacting our world, and we are headed for a highly uncertain summer and fall season. Russia and Ukraine forces need to open up transit passages to allow grain shipments to pass, but there are no signs this will occur anytime soon.
a housing price correction in select areas. With mortgage rates rising, consumers will not have the same financing heft as they did previously. Mortgage rates have risen from 3 to 5 percent over the last few months. This is sure to dampen demand. However, because housing supplies are still constrained, the drop will not be anything near what we saw in 2008. In certain markets, where price gains were most rapid over the last two years - mostly in the western states - there are likely to be declines of anywhere from 3 to 7 percent. Markets showing signs of speculation, such as Phoenix, Charlotte, and the Florida coast might see declines on the higher end, whereas certain areas, particularly in the northeast, might not see declines at all.
On the flip side, these times of corrections in the economy occur once every 10 years or so.
Get used to them.
They will teach you something every time they come. Learn to structure a portfolio that can profit in any type of condition. Take advantage of the low prices that will surely result in sectors such as tech.
And always remember to stay the course. Investing is a long-term game. Don’t let these jabs stray you from your long-term goals.
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