Investment Outlook

More Questions Than Answers

The jump scare is the go-to tactic for horror movies. Filmmakers set us up with sights, sound effects and music. Then, just as the tension peaks, they startle us with a sudden, revealing scene.

A similar scenario is playing out in the capital markets. Investors are on edge due to worries about historic inflation levels, the potential for a Federal Reserve (Fed) policy mistake and the war in Ukraine. With tensions high, we’ve seen significant market swings as jumpy investors react to bits of new information.

Against this backdrop, the U.S. stock market fell into bear territory by June and experienced 22 days with daily moves of 2% or more.¹ This level of volatility is already well above the average of 17 such changes in an entire year since 1990.

Given the market’s distaste for uncertainty, volatility isn’t surprising. What’s more, we expect it to continue. There are just too many unanswered questions about inflation’s trajectory, the Fed’s ability to orchestrate a soft landing and when and how the tragic war in Ukraine will end.

Inflation Remains a Top Concern

As of May, inflation sits at the highest level in more than 40 years. Furthermore, the timeline for returning to “normal” levels is unclear, as is the definition of what will pass for normal. This lack of clarity is a significant source of volatility.

Because inflation began climbing more than a year ago, base effects may begin to make year-over-year inflation readings look better on the surface. However, digging deeper, there’s plentiful evidence of continued upward pressure on prices, especially in housing, energy and food.

Rising prices also are top of mind for corporate management teams. This topic came up in 84% of conference calls with investment analysts during the first-quarter reporting season.² The focus on inflation may benefit companies that can help cost-conscious businesses streamline their operations. But prolonged inflation alters spending behaviors, punishes consumers and reduces corporate earnings.

The Fed Has a Challenging Path

We were concerned about inflation before it started showing up in the data. In our view, the Fed put itself in a difficult position by getting a late start on its tightening regime. With widespread inflation across the economy, the Fed faces a more daunting task of sizing and timing interest rate hikes while withdrawing market liquidity without tipping the economy into recession.

My colleagues John Lovito and Charles Tan are skeptical of the Fed’s chances of taming inflation. They cite a long history of Fed tightening cycles followed by recessions, particularly when inflation was high and ascending.

Still, it’s the unknown that investors fear. And while the impact of the Fed’s rate-hiking plan is unclear, investors have responded positively to occasional moments of clarity. For example, the market gained ground when the Fed released meeting notes indicating policymakers agreed on upcoming hikes and increases would align with previous expectations.

War’s Impact Is Felt Around the Globe

Russia’s invasion has devastated Ukraine and triggered a widespread humanitarian and economic crisis. In addition to thousands of deaths and immeasurable suffering, Ukraine’s economy and infrastructure are in shambles. The effects ripple well beyond the battlefield.

Russia’s blockade of Ukraine’s grain exports has choked much-needed trade for Ukrainians and reduced the grain available to nations that desperately need it.

According to the Center for Strategic & International Studies, Russia and Ukraine accounted for more than 25% of global wheat exports before the war. Further, 50 nations rely on the combatants for at least 30% of their wheat imports.

Meanwhile, the West’s imposition of harsh sanctions has isolated Russia financially and plunged its economy into a deep recession. The World Bank expects ripple effects to hit other countries in the region and predicts many will fall into recession this year.

The sanctions also delivered another shock to global supply chains. Until this year, Russia was the world’s second-largest crude oil exporter and provided one-third of Europe’s energy needs. Russia and Ukraine are also significant exporters of natural resources used in industry.

Maintain Your Investment Discipline

Answers to the questions hanging over the market will come to us in bits and pieces. We expect this to result in continued volatility because some market participants will react to new information like the jump scare I mentioned earlier.

We tend to view new information as another piece of a puzzle. As I mentioned in May, it will take time to piece together enough data to build conviction around today’s uncertainties. Investors will have better foundations for making informed decisions as the fog clears.

In the meantime, don’t let your guard down when it comes to managing risk. For example, inflation-protected strategies can help combat the destructive power of rising prices in bond portfolios.

A stock allocation that blends value, growth and income-producing strategies can help account for investment styles rotating in and out of favor. Also, geographic diversification can help compensate for volatility that is focused on a single region.

We can’t predict the outcome of the uncertainties. But history and research have demonstrated that investors who commit to a long-term asset allocation policy with disciplined risk controls are likely better equipped to take advantage of the market’s volatility.

Thank you for entrusting us with your capital.

¹FactSet, American Century Investments, as of 6/14/22.

²FactSet.