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Core Comments Quarterly Newsletter, 2nd Quarter, 2022

April 8, 2022

Last time I said Covid is on its own schedule, and I still believe it is true. At the beginning of the year Omicron was again filling up the hospitals but it also spurred vaccinations and it has receded in the US and Europe now to the point most restrictions have been lifted. I recently heard that it has been estimated that 95% of Americans now have some immunity either through vaccination or from surviving the infection. On the other hand, China has not had the same success with Omicron as it did with its predecessors. Their lockdown tactic has not worked well against the easily transmissible Omicron variant. The economic consequences of these lockdowns may slow their economy and therefore leave the rest of the world short of inventory which could put more inflationary pressure into world. It is too soon to know just how much this will affect the Chinese economy, which is intentionally opaque, but the potential inflationary consequence will be obvious as the goods shortages cannot be hidden. Hopefully this stimulates onshoring of the manufacturing of goods that are of critical importance.

The world did not need any additional economic or humanitarian turmoil beyond what Covid has wreaked/ wrought. Four days after the end of the Winter Olympics’ global hug fest, Russia invaded Ukraine. The world responded with limited aid and massive sanctions on Russia. Western Europe which had lulled itself into believing that nothing like this could happen now finds itself depending on Russian natural gas. Thus, the sanctions exclude natural gas, so the western Europeans did not freeze this winter. Russia and Ukraine together export significant quantities of grains and other agricultural products. The sanctions will keep Russia out of the market and the war will at least reduce Ukrainian output. Russia is the largest exporter of agricultural fertilizer at $7 Billion US. Where do we make that up? It is likely that the price of fertilizer will rise, and many farmers will not be able to secure adequate supplies. Ukraine is the world’s largest exporter of Neon gas which is necessary to produce computer chips. It is too early to understand all the economic consequences of the war, but it is likely to have a negative effect in terms of inflation and slowing global growth.

As you would expect given these events global stock markets struggled. At one point the S&P 500 was down 13% before to a loss of 4.6% for the quarter. Small stocks were hurt more with the Russell 2000 index down 7.5%. Growth stocks and especially the largest companies in the S&P 500 were hurt the most while value stocks fared better. Or one could say the FANG was somewhat defanged.

The surprise for most investors was the selloff in the bond market. The Aggregate Bond Index lost 5.9% in the quarter, while the High Yield Index lost 4.84% the 10 Year Treasury bond lost 6.86%. This was a very significant move in the bond market which most of us think is a sleepy place, but this shows that it can be very volatile at times. So, what triggered this event? I suspect most of the movement can be traced to all the recent reports on inflation and the Federal Reserve’s decision to hike the Fed Funds Rate to fight inflation. The Covid and war news no doubt had some impact. In the end it is not possible to ever know exactly what factors caused any market move.

For now, the Fed is committed to fight inflation as unemployment, their other mandate is at one of its lowest readings and appears to be headed lower. The futures markets are predicting seven more increases this year so should you expect similar volatility with each increase. Probably not as the market is now on notice that rates are moving up and, in the end, higher rates make bonds more attractive and help curb inflation.

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