The Fed’s Difficult Job of Navigating a Soft Landing

April 8, 2022 –  While it is never one thing that influences the course of markets, lately it could seem that way. Inflation was of no concern for decades, and now it is at the highest reading in 40 years. Inflation is about supply and demand: too many dollars chasing too few goods and services, which results in higher prices. In the past few years, supply has been stifled by tariffs, the COVID shutdown, labor shortages, supply chain disruption, and now war and necessary sanctions. At the same time, demand has surged, spurred by excessive COVID stimulus spending and policies.

The Federal Reserve is tasked with a dual mandate. First, to maintain maximum employment. And second, to keep prices stable and long-term interest rates at moderate levels. The Fed’s post-COVID focus has shifted from employment to prices. One tool the Fed uses to deal with high inflation is boosting interest rates. Slowing down the circulation of money in the economy results in lower demand. To get a handle on fast-moving inflation, the Fed will have to take bold actions and be willing to rapidly adjust policy as developments dictate. This more aggressive approach is likely to cause volatility in the financial markets. However, we are hopeful that the Fed’s bold response will improve the outcome for the economy. Ideally, the Fed will engineer a soft landing, while avoiding a recession.

At the same time, Putin’s war on Ukraine continues. Sanctions on Russia remain and could be increased. Supplies of oil and other commodities will likely be affected for years to come. One positive result could be the reconsideration of previous geopolitical alliances. New, reordered, and stronger alliances with the West and much of the world are developing. How China chooses to navigate this new geopolitical world, specifically its relationship with Russia, will be important in this global reordering.

In our investment management role, we have the opportunity and challenge to manage your retirement and family portfolio assets though volatile times. We work to keep the ultimate purpose of the investment portfolio in focus, while ensuring current needs are met in the near term. We will manage risks and tax consequences and, as importantly,  take advantage of opportunities presented by unpredictable market actions.

Despite the recent volatility, U.S. stocks are still, in our view, the most attractive of the major asset categories. Sectors, such as energy and utilities, stand out in times of rising prices. Former COVID beneficiaries such as new digital technologies, biotech, real estate, and communications services have given back a small part of the outsized gains of the last few years. We want to limit exposure to parts of the market most at risk from higher interest rates, while looking for value opportunities. These opportunities may be found in overly discounted tech names, or cyclical businesses such as banks and, industrial and transportation companies.

Global growth is expected to slow, driven by sanctions on Russia and higher interest rates. The euro area economy is most affected by the war, and expected growth rates have dropped from prior estimates of 4.5% down to 2.0% in 2022. We intend to keep our target allocations in foreign stocks, while considering geographic region exposure and economic sector weighting.

The area of fixed income may be the most challenging to manage in this market, but is not necessarily unattractive. We “ladder” portfolios of individual bonds with two through six-year maturities. We use tax-exempt municipal bonds in taxable accounts and corporate, taxable municipals, CD’s, and mortgage-backed fixed income in IRA accounts. Buying individual bonds allows us to know the rate of return when we buy the bond and lock in that income. Since we hold bonds to maturity and do not trade them, market price changes during their term are not relevant to these portfolios. Laddering gives us the opportunity to reinvest maturing bond proceeds in longer maturity bonds at the new, higher yields. We also use added cash to help rebalance bond portfolios at higher rates of return. We have increased allocations to floating rate notes which are helped by rising short-term rates. Inflation protected bonds worked well in 2021 but are less attractive now at, hopefully, near-peak inflation readings. In addition, preferred stocks and convertible bonds each currently offer unique advantages.

Although we provide an overview of many areas of the market, our focus when managing your portfolio is on your personal goal and an individualized strategy to reach that goal. We welcome your feedback and questions.