Inflation – Why Is The Market Freaking Out?

Inflation Chart 2022

Inflation Chart 2022

Inflation and other events are impacting the financial markets resulting in increased volatility. I've heard it said that “history doesn't repeat itself, but it rhymes.” If you look back at significant world events and their impact on financial markets, you will see wars, pandemics, natural disasters, and financial crises. What is going on today isn't necessarily new, However, that doesn't minimize the signficance of the events. Let's take a look at these events and determine what, if anything, we should do with our investments.

Inflation & The Federal Reserve

As the economy roared back from the depths of the pandemic and flush with cash from zero interest rates and stimulus, inflation started rearing its head. With the Federal Reserve raising rates, we've seen a steep rise in the 10 year treasury now around 3.0%. Mortgage rates have followed suit with average 30 year rates around 5.5%.

In late February 2020, inflation was the least of our concerns. It became clear Covid-19 would have a disasterous impact on the global economy. Central banks around the world flooded the system with cash by slashing interest rates to zero. Additionally, governments passed aggressive stimulus plans to stave off a severe recession and possibility of a second Great Depression. Yes, the prospects were that grim.

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Oil prices collapsed due to the drop in demand. At one point, there was so much supply that oil had to be stored on ships and at other facilities. For a time, suppliers couldn't even sell their oil. They had to pay to have people take delivery of oil. Stop and consider how significant that is. This resulted in a bizarre price event that turned the price of a barrel of oil negative! According to Daniel Yergin, author of The New Map, “on April 20, 2020…the lowest price ever recorded for a barrel of oil – minus $37.63.”

These price distortions didn't last long, and as the global lockdowns began to ease, people got back into their cars. Demand increased and has been increasing ever since.

By late 2021, the booming economic recovery in the U.S. was evident by record low unemployment, record high stock market, and record high real estate values. Our economy and others around the world simply got too hot to handle.

Central banks around the world no longer fear recession or depression, they fear inflation and that's why rates are heading up.

Russia's Invasion of Ukraine

Markets don't like uncertainty and Putin is the ultimate wildcard. While Ukraine is providing stiff resistance and successfully defending their country, some fear Putin could, in desperation, resort to more extreme measures like chemical or nuclear weapons.

In addition to a major war raging in Europe, uprecedented economic sanctions have been levied against Russia. While necessary, these sanctions will have negative impacts on the West. Examples include rising commodity prices for consumers (gas & oil) and lost revenue for Western businesses no longer operating in Russia.

Russian military losses have been substantial. With sanctions, it has become difficult, if not impossible for the Russian military industry to replace military hardware. This is leading some military analysts to conclude Russia can not achieve its military objectives. That's another way to say Russia is likely to lose the war.

At the start of the invasion, analysts were considering the likelihood the Ukranian government would fall and Russia would take over the country. Two months later, those same analysts are considering the possibility of Putin losing power. It may be time to start considering the possibility of political and social unrest in Russia in the coming months and the impact that may have on financial markets.

Inflation And The Covid Surge In China

While Covid numbers have been dropping considerably in the U.S. and the West, China is back to the lockdowns. Chinese authorities have locked down Shanghai and Beijing which will limit exports further impacting supply chains. Not to mention that China has one of the biggest economies on the planet and it's grinding to a halt.

China was hit hard from the initial outbreak in late 2019 and early 2020. They were returning to normal as we were shutting down. However, due to their refusal to use the MRNA vaccines developed in the west, their population is being hit even harder now by the Covid variants.

China has been a huge driver of economic growth. With export levels dropping, this could add some fuel to the inflation fire. At the time of this writing, there is little indication the Covid-19 numbers are improving there. In fact, some economists are reducing their GDP forecasts for China.

While the Chinese economy is usually the main focus, some analysts are keeping an eye on the growing frustration among its citizens. In the U.S., we use the term “lockdown” rather loosely. We never really had lockdowns here. We were free to move around with certain restricts. In China, they literally lock people inside their apartment buidlings by installing fencing so people can't get out. This is happening in China's biggest cities and there are growing reports of discontent among residents of Beijing and Shanghai.

It remains to be seen how far the Chinese authorities are willing to go to maintain their “Zero Covid” policy. It's also unknown how long the Chinese people will put up with it.

Conclusion

There are other factors at play but these are the big ones. Now what should you do about it? Unless you're a day trader, likely nothing. By that I mean, changing your portfolio in the middle of a volatile period like this doesn't make much sense. Having said that, it can be beneficial to reallocate your porfolio to keep things in balance.

As investors, it is important that we don't let short term market moves affect our decision making. I know it's easier said than done, but I've seen it work time and time again over the last 20 years.

I like to remind my clients there is never a flashing green light indicating a safe time to invest. There will always be war, pandemics, or other dangers around the proverbial corner. We should expect there will be tough times and be wise enough to know they don't last forever.

That isn't to say we should put our heads in the sand and pretend everything is ok. At the same time, we need to be realistic about what we can and can not control.

Inflation won't last forever. Russia's war against Ukraine will end. The pandemic will run its course.

Investing with confidence and having the right expections will go a long way toward helping you achieve your goals.

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