Thrivent market & economic update [VIDEO]
Understanding the economy and managing market fluctuations
Understanding the economy and managing market fluctuations
The tragic invasion of Ukraine adds yet another dimension to the recent economic turmoil.
Over the past five years, the economy has faced a variety of challenges, including a trade war, significant tax policy changes, a global pandemic, social/political discord, a severe but incredibly short recession, unprecedented government spending, and a stock market collapse followed by an historic rally. Up to now, financial markets have been amazingly resilient, generating unexpectedly high returns over the past five years.
Against this backdrop, inflation had been surprisingly muted and consistent, remaining in a narrow range around 2%. It was this constant that allowed the Federal Reserve (Fed) to maintain accommodative monetary policies, some of which originated in the great financial crisis of 2008, and to provide monetary support during the pandemic crisis.
For investors concerned with rising inflation and the international crisis, investing in stocks or stock mutual funds that focus on valuation and fundamentals has become much more important. Companies with solid business plans, cash flow, and dividends are again relevant rather than disruptive innovators, initial public offerings, or alternative investments such as cryptocurrencies.
For many years there have been critics of the Fed who believed that easy money policies would eventually lead to an inflation problem when too much money chased too few goods. However, like the boy who cried wolf, these concerns never materialized – until now.
The most recent Consumer Price Index (CPI), which is a commonly used gauge of inflation, was up 7.5% on an annualized basis, much of it due to supply chain issues. Now, war in Europe is causing commodity prices to soar and supply uncertainties to increase, magnifying concerns over inflation.
The Ukrainian situation presents a new problem for the Fed due to the impact that severe financial sanctions may have on global payment systems, liquidity and, ultimately, the stability of financial markets. Consequently, the Fed will need to factor this new reality into its policy initiatives that were expected to begin in March.
In addition to increasing short-term interest rates, the Fed is also poised to not only discontinue its large bond buying program but may consider actually selling some bonds out of its massive $9 trillion portfolio. The goal is to raise interest rates in order to moderate excessive demand that is adding to inflationary pressure.
This relatively sharp monetary policy pivot, in response to building inflationary pressures, has led to significant volatility and declines in the stock and bond markets. It has also added to the underlying anxious environment that has prevailed since the pandemic began.
Traditionally, when the Fed pursues tightening policy measures, the economy tends to slow and, oftentimes, eventually declines into recession. Bond prices typically decline (with rising interest rates) and stock prices may sometimes falter. Investment decisions are thus more challenging. However, some of the conventional thoughts on investing when inflation is moving up may provide only minimal benefits.
Conventional approaches to defending a portfolio from inflation typically focus on commodities (especially gold), Treasury Inflation Protected Securities (TIPS), and real estate. Although these may have a place in a well-diversified portfolio, excessively reallocating a portfolio to these areas can detract from long term wealth accumulation:
Worries over inflation typically lead investors to consider the “alternative” investment areas of commodities, gold, TIPS, and real estate. But common stocks, which represent the core asset class for most investors, have historically generated reasonable long-term returns, relative to these alternative areas, even in an inflationary environment. Over longer periods of time, common stocks have typically generated meaningfully higher returns than most inflation hedging “alternative” assets.
However, an inflationary environment provides unique challenges for corporate management teams to generate returns for shareholders. Managing costs, efficiently allocating capital, and astutely managing balance sheets becomes paramount. Companies that demonstrate these virtuous characteristics, regardless of capitalization size, have recently been performing well relative to the overall market.
It has been decades since inflation was truly a problem for the U.S. economy. The tragic events in Ukraine also may add to the potential for inflationary pressures to persist. However, some of the conventional alternative asset classes that are thought to provide meaningful protection against inflation may not provide enough of an advantage to warrant dramatically altering a portfolio.
Markets on average have historically recovered relatively quickly from geopolitical events such as armed conflicts and politics. The odds are stacked against most investors being nimble enough to execute tactics in their overall portfolios to take advantage of such short-term market action.
A well-diversified portfolio certainly can include gold, TIPS, and REITs, as well as other assets that may marginally perform better in a more inflationary or crisis-oriented environment. But making significant allocations to these areas at the expense of core equities in hopes of gaining significant protection from inflation or geopolitical turmoil is likely to result in diminished long-term performance. It may be helpful to consult with your financial professional before making any changes in your portfolio.
All information and representations herein are as of 03/04/2022, unless otherwise noted.
The views expressed are as of the date given, may change as market or other conditions change, and may differ from views expressed by other Thrivent Asset Management, LLC associates. Actual investment decisions made by Thrivent Asset Management, LLC will not necessarily reflect the views expressed. This information should not be considered investment advice or a recommendation of any particular security, strategy or product. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon, and risk tolerance.
Any indexes shown are unmanaged and do not reflect the typical costs of investing. Investors cannot invest directly in an index.
Past performance is not necessarily indicative of future results.