Summer is here! It’s time to relax and enjoy the sunshine. Are you ready for the barbecues, beach days, and movie nights? Just like a good movie will have strong protagonists and antagonists, so does the market. The current antagonists impacting the economy are inflation, interest rate hikes, Russia-Ukraine, and Covid-19. However, the goal is that our protagonist, the health market, will persevere in the long run. At this point in our movie, each character plays a role in affecting the economy, and we, at Corinthian Wealth Management, continue to monitor and manage the impact the different roles have on your portfolios.
High inflation isn't news anymore. Since the beginning of the year, all we've heard about is inflation and increasing interest rates. These economic changes have created fear in investors putting downward pressure on the market. Inflation has reached an all-time high since the 1980s, causing panic selling among investors and uncertainty. Moreover, inflation is on the rise. The Consumer Price Index report posted by The US Bureau of Labor Statistics shows an increase of 1% in May, totaling 8.6% on all items over the last 12 months. Fuel oil, shelter, and food were among the largest contributors to this increase. Soaring prices for basic needs affect lower-income consumers leaving them with little to no discretionary income to spend or save.
The Bureau of Economic Analysis news release shows a decrease in personal savings rate, currently at 4.4% as of April, a 1.6 percentage points decrease from the beginning of the year, the lowest it has been in a decade. However, individuals are spending more on goods and services as prices have increased and the COVID restrictions have eased.
Supply chain issues have lingered since the pandemic and have exacerbated the inflation problem we are facing. Supply shortages accompanied by high-demand increased prices, has created an imbalance between supply and demand. The Economic Letter written by Adam Hale Shapiro, economist for the San Francisco Federal Reserve bank, stated, "…supply factors explain about half of the run-up in current inflation levels. Demand factors are responsible for about one-third, with the remainder resulting from ambiguous factors. While supply disruptions are widely expected to ease this year, this outcome is highly uncertain". Other factors such as labor shortages and global disruptions have contributed to supply chain issues, which the Federal Reserve can't control to bring down inflation. The PMI- Purchasing Managers Index, a leading indicator which measures the economic trends and manufacturing sector was released on July 1st decreased to 53 points in June from 56.1 in May, affirming that we are in a contraction and supply issues will continue in the short term future. Despite the decrease during this month, forecasts are optimistic and we hope to see some improvement by the end of the year.
The Fed is determined to stay on track with its plan of raising interest rates to combat inflation while minimizing the probability of a recession. Although many argue that we are already in a recession, some economic factors say otherwise. With the latest interest rate hike of .75%, the market took a huge hit where all sectors, even energy, the best performing sector year to date, had losses after the announcement. Investors fear this will continue as the Federal Reserve does not plan to back down and continue its interest rate hikes for the rest of the year. Potentially, we may see an interest rate hike of 75 basis points by the end of next month, so what does this mean? The goal of the Federal Reserve is to control inflation while maintaining a healthy economy, and by raising interest rates, consumers borrow less, thereby reducing the money supply. Moreover, there is an inverse relationship between interest rates and bond prices. When interest rates go up, bond prices go down. Therefore, interest rate hikes have greatly affected the bond market. A way to mitigate the impact of rising interest rates is to stick with short-duration and high-quality bonds.
Russia's invasion of Ukraine is in its fourth month, and they are no closer to a resolution. This invasion is happening because Russia wants to maintain control over the Crimean Peninsula, a strategic location for the country. Russia is also trying to destabilize the Ukrainian government to maintain its regional influence. This invasion has led to a lot of violence, death, and humanitarian crises.
Russia is the main contributor to the world commodities of oil, gas, wheat, nickel, aluminum, and Palladium. As a result, the Russia-Ukraine war has impacted global economic activity and inflation in the form of higher energy prices, commodity prices, and food shortages. Inflationary pressures were already presenting themselves before the invasion, and this war has added another layer of complexity.
Recently, the United States and European Union have imposed unprecedented economic sanctions on Russia in response to the country's invasion of Ukraine. Sanctions are imposed as penalties from one country to another to influence them from breaking international laws or stopping them from acting aggressively. These sanctions have limited Russia's access to global capital markets, restricted its defense and energy sectors, and targeted its financial institutions. As a result, the sanctions from various countries have caused exports to Russia to decline by about 60 percent, while exports from non-sanctioning countries fell by about 40 percent.
You may be wondering what these sanctions' impact on Russia is. The country went into an economic crisis and responded quickly to control the immediate effect of the sanctions. Russia's central bank hiked interest rates to 20 percent and regulated capital tightly. The country continues to sell its oil and gas, which has aided in countering some of the sanctions' impacts. On June 27th, 2022, it's believed that Russia defaulted on its debt for the first time since 1998. Due to its inability to access capital by imposed sanctions, Russia could not complete the debt payment. The economic sanctions will impact countries that rely on Russia to provide any of their commodities.
Geopolitical and economic uncertainty will remain elevated until military operations end. However, at this point, we do not see a clear picture that is visible on the horizon.
What's new with Covid-19? Well, we are still dealing with it after more than two years. CDC has approved the Covid-19 vaccine for children under five. The US has seen an increase in Covid-19 cases and hospitalizations since April 2022. For now, these are the significant changes in the US from our last update; mask mandates are no longer enforced on public transportation, and restaurants and retail stores are back in business. Some businesses are working at lower capacity due to the lack of labor force, but they are open for business. We are far from our peak levels or reaching hospital capacity. The panelist at the Food and Drug Administration's Vaccines and Related Biological Products Advisory Committee is predicting another surge in cases in the fall and winter. The idea is for the scientist to develop a new vaccine that protects us against the various variants.
China's lockdowns due to Covid-19 have impacted industrial production, creating more pressure on the supply chain with delays and disruptions. May's seasonally adjusted monthly factory output rose 5.6%, making it the best since March 2020. The chart shows a downward trend, but the Focus Economic Consensus panel sees industrial production rising to 4.9% in 2022 and 5.0% in 2023.
The potential for improving supply chain and production issues at home and abroad lies in the balance of keeping the Covid-19 cases and hospitalizations at a minimum and avoiding a significant upsurge in the fall and winter to avoid future disruptions.
As these market conditions persist, Corinthian Wealth Management continues to monitor our clients' portfolios carefully. In this market, bonds are no longer the safety cushion to protect principal, and as with any investment, they too carry several types of risk. Stocks are known to have less purchasing power risk than bonds but carry more downward risk causing them to be more volatile. With high inflation and rising interest rates, we have taken action by tilting our equity side towards value and our bond side towards short-duration and high-quality bonds. As always, our focus is long-term investing by maintaining liquidity and diversification to meet our clients' investment objectives.