Capital Market Comment
March 17, 2022
Frank Mastrapasqua, Ph.D.
Principal, Chairman & Chief Investment Officer
Navigating The Conflicts
The financial markets have been challenged with a multitude of conflicting forces. Strong employment growth in January and February provides a firm backdrop to an expanding economy while high inflation is eroding the purchasing power of the “Consumer”. Exacerbating the inflation problem is the Russian invasion of Ukraine and the resultant impact on oil and agricultural prices. More importantly, the loss of human life, the massive destruction of property, and the millions of Ukrainian refugees highlights the human tragedy unfolding before our eyes.
Under the weight of sanctions and the independent actions of many companies, the Russian economy has contracted dramatically and appears to be in a freefall. Moreover, the estimates for growth in the European community are being lowered, but the extent is difficult to determine.
Public policy, specifically monetary policy, is faced with countervailing forces—increasing inflationary pressures, slowing growth, and the prospect of financial dislocations. Although a big contributor to inflation, the spike in energy prices as well as agricultural prices cannot essentially be influenced by monetary policy. Historically, when the monetary authorities have responded to energy induced inflation (as was the case in 1974), they have either caused or contributed to an economic downturn. As painful and troublesome as the inflationary cycle is, managing through it will be difficult, but may prove to be a better path.
Engaging in a monetary policy that induces demand destruction would require a level of monetary restraint that would most surely produce recessionary conditions—rising unemployment, financial stress, etc. As a result, the Fed would have to reverse course with all the attendant consequences of those actions.
Recognizing that the monetary authorities are “behind the curve” as many pundits have said is easy with the benefit of hindsight. The pandemic with all its unknowns produced a degree of financial stress that required bold and aggressive monetary action. Closing the economy down with little visibility as to when it would reopen, a growing number of business failures, and a capital market that ceased to function provided no road map for policy.
At this juncture, the “reopened” economy appears to be performing well with the employment gains that are being recorded, but supply chain issues remain, and they are further complicated by the Ukraine crisis.
Going forward, economic growth is likely to slow. The Atlanta Fed forecast is for a Q1 2022 growth rate of less than 1% with consensus at 1.5%. The February retail sales data along with the January revisions and the housing starts and permits report would suggest that these growth rates will be revised upward.
Forecasts have to be made, but they will change often. In the March 14, 2022 issue of Barron’s, a reference was made to the 1974 experience when President Ford held a large conference in Washington to address the inflation problem [WIN-Whip Inflation Now]. I attended that event and in-depth discussions took place. However, it became apparent shortly thereafter that inflation was yesterday’s concern, and recession was the new problem—the recession had been underway for a year.
As we indicated in a prior commentary, the Federal Reserve communicated a pivot in policy at the November FOMC meeting and began reducing the pace of buying securities at the December meeting. The January meeting accelerated the reduction of the purchases, which has ended in Mid-March. Until this juncture, the monetary authorities had been adding to their balance sheet which reached $9 trillion and maintained a 0.00-0.25 federal funds target. At the March 16th meeting, they have begun the process of raising short-term interest rates, with a 25 basis point increase in the federal funds rate and a forecast of 6 additional increases this year and 3 in 2023. It was not that long ago that their forecast showed no increase in 2022. It is important to note that a changing environment with as many cross currents as exist today is likely to bring adjustments to the forecasts in the coming months.
In our judgement, if the Fed essentially follows the path that they have laid out, short-term rates are unlikely to be problematic for the economy and the equity market, because the fed funds rate will likely remain below the inflation rate into 2023 (which has been historically bullish for the stock market). A significant change to the outlined monetary policy with a more aggressive attempt at restraint would become an obstacle for the market.
Over the short-term, the equity market faces significant uncertainty from exogenous events –Ukraine, China etc. Until greater clarity emerges, volatility will remain and market participants will struggle with the appropriate strategy to employ. However, the Fed’s decision announced on March 16th reduces a major uncertainty variable.
At this point investor sentiment has become very negative –the AAII bullish index fell to 22 and the bearish index was over 49 (a good contrary indicator). These are levels associated with market bottoms. Moreover, cash positions are piling up.
From a longer-term perspective, several themes seem likely to benefit from the changing environment. Within technology, cybersecurity, artificial intelligence, cloud computing, and e-commerce are some of the areas. Given the sharp correction that has taken place in this sector, and the purging of companies with no clear path to profitability, valuations have become attractive. Healthcare, aerospace and defense, agriculture, and infrastructure also look promising.
Mastrapasqua Asset Management, Inc. does business as M Capital Advisors. If you have a question or need further information, please contact:
Edwin Barton, Principal, Portfolio Specialist & Head Trader in Nashville at 615-255-9898, firstname.lastname@example.org
Claude Koontz, CFA, Principal & Portfolio Manager in San Antonio at 210-353-0519, email@example.com
© 2022 Mastrapasqua Asset Management, Inc. All rights reserved.
The information and opinions contained in this report should not be treated as fact or as insight that will produce desired investment results over time. Investment conclusions always bear risk, and that risk may not be reasonable for any particular reader. Obviously the writer, even assuming good intentions, does not know of the reader’s particular financial circumstance and therefore is not able to assess the propriety of whether a named security makes sense as part of a given individual, family, or institutional portfolio. Mastrapasqua Asset Management clients may, from time to time, own some of the companies mentioned. We hold out no duty to give readers of this column advanced notification of when we may change an opinion. Investors should receive investment advice based on an assessment of their own particular investment circumstances and not on the basis of recommendations in this report. Past performance is not indicative of future returns.