Russia, The Fed and Earnings
Russia invaded Ukraine this week in what was the largest European invasion since WWII. I don’t think anyone knows how this will play out, or what President Putin’s endgame is. The market doesn’t like uncertainty, and it’s no surprise the volatility we are seeing leading up to and after the invasion. This volatility shouldn’t last long-term.
Of more concern is how will the invasion impact US economic activity. This is important, as it will most likely have a longer-term impact on stocks.
US exports of goods to Russia last year totaled $6.4 billion, according to the US Census. It’s a tiny percentage of the US GDP. The indirect impact is more of a concern, as the EU is the largest Russian trading partner and accounts for 40% of Europe’s natural gas imports.
We’ll probably see more sanctions and rising energy prices, which will likely add to inflation, covered more in-depth below.
The most common market fears have been the same throughout the history of the stock market: rising interest rates, higher inflation, wars, slowing economic growth, high market valuations…
It’s what investors are concerned about now, and if you dig up a newspaper from 25, 50, or 100 years ago, you will find the same worries. These things always happen and they always will happen.
It can feel scary to stay invested amidst everything that’s going on now. Yet, despite all of these fears, markets have carried on going higher through time. Long-term investors who managed to stay invested despite the reasons not to, have done extremely well.
The Federal Reserve & Interest Rates
While it may feel like it was so long ago… it was only last year that the Federal Reserve said they would begin tapering bond purchases in the second half of 2022, and begin raising interest rates cautiously in 2023. As of now, it seems the Fed is pivoting, and there is talk of up to seven rate hikes this year.
Many anticipate that the rate hikes will start at the March 16th Federal Reserve meeting.
The Fed could do an emergency hike prior to the next meeting, but that is unlikely, as it signals they are in panic mode.
How Aggressive Will the Fed Be In Raising Rates?
The last time there was a truly aggressive rate-hike cycle was in 1994, led by Fed Chairman Alan Greenspan. It was a preemptive strike against inflation, as the Consumer Price Index (CPI) was relatively low and the economy was far from full employment. The rate hike cycle included three 50bp rate hikes and one 75bp rate hike. The Fed funds rate rose from 3% to 6% in one year. One thing to note is that stocks finished 1994 nearly unchanged.
Today is different. The CPI is at 7.5%, the jobless rate is 4.0%, the fed funds rate is 0%-0.25%. The hike now would not be a preemptive strike, but a countermeasure against rising inflation. The comments by Fed Chairman Powell point to an aggressive stance. He said, “I think there’s quite a bit of room to raise interest rates without threatening the labor market.” He did not provide any rate-hike guidance.
There is some disagreement amongst Fed officials on how aggressive they should be. St. Louis Fed President James Bullard is leading the charge for an aggressive response. He said that he would like to see a 100 basis point increase in the bag by July 1. Other Fed officials are not yet convinced an aggressive response is needed.
Given the high level of inflation, a 25bp rate hike at the remaining Fed meetings this year doesn’t seem unreasonable.
Rate hikes are not without risks. The Fed is playing a balancing act of trying to rein in inflation and not create a recession.
Recent, Solid Earnings
It’s not all doom and gloom — earnings have been solid. We’ve been seeing a pattern with the recent release of 2021 fourth quarter earnings. Analysts have been too conservative and companies are topping expectations. The fourth quarter earnings of the S&P 500 companies are projected to rise 31% versus a year ago. Analysts had only projected a 22.3%. There have been some high profile companies miss on hitting their earnings and a lot of them are stating that inflation and supply chain issues will have an impact on future earnings.