PERSPECTIVES ON RECENT ECONOMIC AND MARKET EVENTS
June 27, 2022
Many investors are becoming increasingly concerned as they view potential storm clouds gathering on the horizon. Their concerns include continuing market volatility, rising inflation levels, and slowing economic growth. In this report, we analyze each of these events and identify several potential linkages among them.
The recent fall in equity market indices has heightened investor concern about their future trajectory. With the Standard & Poor’s 500 Index (S&P 500) having entered a so-called “bear market” two weeks ago by falling 20% from its prior high in February 2020, the financial media are awash with doom-and-gloom predictions. However, such pessimism may be overdone.
For example, the graphic below displays the daily price and trading volume of the S&P 500 exchange-traded fund (ETF). As shown, those who remained invested throughout the COVID pandemic are still 15.3% above its February 2020 high, as of June 24, 2022. As importantly, those investors remain 75.0% above the S&P 500’s pandemic market bottom reached in March 2020. Of course, past performance is no guarantee of future returns.
Even with its ultimate trajectory unknown, the S&P 500 has shown significant resilience in the aftermath of historical market downturns. More specifically, as shown in the table below illustrating the five largest market declines since the Great Depression, only two of the 25 annual returns after each downturn were negative. Overall, the average annual total return for those subsequent five years was 23.2%. Even excluding the 35.9% return for the Great Depression years, the average annual return was a significant 19.9%.
Rising inflation levels are another concerning factor, both to investors and households. Because of its recent emergence and increasing strength, inflation warrants an assessment of its key contributors. While myriad inflationary sources have been identified (e.g., supply chain bottlenecks), we would like to focus on two that we believe have been substantial drivers.
As shown in the table below, both existing monetary and fiscal policies were expanded dramatically with the advent of the pandemic. For the three-year period beginning Q1 2017, the money supply—controlled by the Federal Reserve Board (Fed)—had risen at an annual rate of 5.3%. With the onset of its pandemic programs, the Fed boosted this annual rate by a factor of 3X, reaching an 18.0% annual growth rate since Q1 2020.
The federal government also began a series of pandemic-related programs that were dependent upon deficit financing. More specifically, in the three-year period beginning Q1 2017, the federal deficit as a percentage of gross domestic product (GDP) had increased annually by just 1.4%. However, with its pandemic programs, the federal deficit ratio ballooned by a factor of 5X, achieving an annual growth rate of 7.4% after Q1 2020.
The final row in the table above illustrates one potential outcome of these aggressive monetary and fiscal policies, irrespective of their merit. Inflation, as measured by the Consumer Price Index for Urban Consumers (CPI-U), had risen at a 2.0% annual rate for the three-year period beginning Q1 2017. Starting in Q1 2020, the annual inflation rate accelerated to 4.9% and then reached 8.6% in May 2022, its highest monthly rate since December 1981. However, both the Fed and the federal government are ending their respective expansionary programs at this time, so their significant contribution to inflation may soon subside.
A second—and unexpected—major driver of current inflation has been the ongoing geopolitical crisis in Eastern Europe. As the two warring countries are key global suppliers of petroleum and wheat, the inflationary results from this conflict are quite consequential. As shown in the graphic below, the price of West Texas crude oil has risen 19.5% since the conflict began in late February 2022, while the price of processed wheat flour has risen 14.3%. These are both major sources driving heightened inflation and recent market volatility. As there does not appear to be an imminent halt to this crisis, such commodity inflation may continue during the second half of 2022.
With the sudden Fed focus on increasing interest rates, the continuing geopolitical crisis, growing inflationary pressures, and recent market volatility, many investors have heightened concern about a decelerating U.S. economy, as measured by its GDP. A sampling of 2022-2023 GDP growth forecasts from key institutions suggests that, while it is expected to decline in 2023, the economy may avoid a near-term recession.
For another perspective on future economic growth, The Wall Street Journal queries 50+ academic and financial institution economists each month (WSJ Economic Survey) on their outlook for a potential recession occurring in the next 12 months. The June survey results were: 19% of those queried believe the probability of a near-term recession is 25% or less; 50% believe it is between 26% and 50%; and only 31% believe the probability lies above 51%. The average probability of a recession with all forecasts combined was 44%, up from 28% in the April 2022 survey.
However, such forecasts include significant assumptions about future economic and financial forces. These include factors such as the state of the overall world economy; potential geographic crises; a near-term decline in inflation rates; stable federal government spending levels; a cooling of the U.S. housing market; and a less aggressive Fed with respect to future interest rate increases. Because of these and other assumptions, a lack of consensus about future economic growth has also contributed to recent market volatility.
Market volatility, inflationary pressures, and slowing economic growth can be stressful for everyone, but The Mather Group, LLC (TMG) employs a suite of risk management tools with the goal of adding value to our clients’ financial profiles during such cycles. These include initiatives such as tax-loss harvesting to help reduce your overall tax burden, asset class rebalancing to maintain necessary portfolio diversification, and accelerated tax strategies intended to increase future after-tax income.
Although these concerning economic and market factors may be reduced in the coming months, it is important to note the critical role of your financial plan in helping you to maintain progress toward achieving your financial goals. Your trusted TMG advisor is ready to respond to any questions or concerns you might have, and to assure that your financial plan remains both timely and actionable. Please reach out to your advisor for guidance at any time.
Data Sources: Bespoke Investment Group; Bloomberg; Bureau of Economic Analysis; Bureau of Labor Statistics; Capital Group; Conference Board; Energy Information Administration; Federal Reserve Bank of St. Louis; Federal Reserve Board; Goldman Sachs; Morgan Stanley; Reuters; S&P Global; World Bank; US Treasury; Wall Street Journal
The Mather Group, LLC (TMG) is registered under the Investment Advisers Act of 1940 as a Registered Investment Adviser with the Securities and Exchange Commission (SEC). Registration as an investment adviser does not imply a certain level of skill or training. For a detailed discussion of TMG and its investment advisory services and fees, see the firm’s Form ADV on file with the SEC at www.adviserinfo.sec.gov, or on the firm’s website at www.themathergroup.com. The opinions expressed, and material provided are for general information and should not be considered a solicitation for the purchase or sale of any security. The opinions and advice expressed in this communication are based on TMG’s research and professional experience and are expressed as of the publishing date of this communication. All return figures and charts shown are for illustrative purposes only. TMG makes no warranty or representation, express or implied, nor does TMG accept any liability, with respect to the information and data set forth herein. TMG specifically disclaims any duty to update any of the information and data contained in this communication. The information and data in this communication does not constitute legal, tax, accounting, investment, or other professional advice. Investing involves some level of risk. Past performance does not guarantee future results.
An index is a portfolio of specific securities, the performance of which is often used as a benchmark in judging the relative performance of certain asset classes. Indexes are unmanaged portfolios and investors cannot invest directly in an index, as an investment vehicle replicating an index would be required. An index does not charge management fees or brokerage expenses, and no such fees or expenses were deducted from the performance shown. Please feel free to contact us for additional information on any indices mentioned.
Indexes
- Standard & Poor's (S&P) 500 - A stock market index that measures the stock performance of 500 large companies listed on stock exchanges in the United States.
- Consumer Price Index for Urban Consumers (CPI-U): A measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.
