We entered 2022 with a focus on impacts from the Covid Omicron Wave, rising inflation and the likely response from the Federal Reserve. In February, Russia invaded Ukraine. The war triggered not only concerns about an escalation of the conflict and potential realignment of alliances; it also introduced uncertainties to the broader global economic recovery. Most immediately, many commodity prices saw large spikes.
For instance, energy prices, which had already been rising due to the “return to normal” saw a dramatic increase during the quarter. Brent Oil, which began the year at $79 per barrel spiked to a high of $133 per barrel in early March. We saw similar moves in natural gas and agricultural commodities for which Russia and Ukraine are important global producers. More recently, many of these commodity prices have retreated, not due to the war-related issues, but rather due to rising concerns of a global slowdown.
China, which is a significant purchaser of global commodities, has up until now weathered the Covid pandemic relatively well; but, of late, it is facing a serious test to its Zero-Covid policy. Hong Kong saw a significant spike in cases peaking in March, while cities in mainland China, including Shanghai and Beijing, are starting to see cases rise rapidly, which is resulting in stringent lockdowns. The U.S. State Department has ordered non-essential personnel to leave Shanghai. These lockdowns are providing some relief to commodity prices as demand wanes, but they raise additional concerns about supply chain disruptions and global economic growth.
Looking at prices overall, for the 12-month period ending in March the Consumer Price Index (CPI) rose 8.5%, the fastest gain in over 40 years. However, core inflation – which excludes food and energy prices – rose only 0.3% during the month, less than had been expected. This suggests that March inflation, which includes the spike in energy prices from the war, possibly represents the peak inflation reading. Going forward, inflation will likely remain at elevated levels, but the year-over-year comparisons should improve.
High inflation has been a driving force for the rise in interest rates. The Federal Reserve raised the Federal Funds Rate for the first time since 2018 and disclosed that it would start to shrink its balance sheet by roughly $95 billion per month starting later in the year. The benchmark 10-year treasury rate rose from 1.51% to 2.33% during the quarter and rates have continued to increase in April. Significantly for housing and future consumer spending, mortgage rates have gone up, with the average 30-year fixed-rate mortgage rising from 3.11% to 4.67%. Not surprisingly, the applications for new mortgage loans declined significantly.
Focusing briefly on fixed income assets under management, anticipating the fight against inflation and the ‘return to normal’, though not the war, we have over the past few years shortened the average maturity of our holdings from about five years to roughly one year. Late last year and through the beginning of 2022 we have shifted purchases toward funds with floating interest rates. While the aggregate bond market was down close to 10% last quarter, our bond holdings combined were down less than 2%. We expect yield to overcome this mild decline in the coming months. Prospectively, given the rise in rates and likely long-term success of the Fed against inflation we will soon be looking for opportunities to grab more yield, extend maturities a bit, and upon excellent opportunities return to investing in individual bonds. The latter will help lock in returns and reduce price risk.
Regarding stocks, we reinforce our long-term perspective. In general, we look for companies with strong market positions that can benefit from multi-year secular trends. Sometimes these can include companies about which the market may have short-term concerns (for example, supply interruptions), for which the stock price has pulled back. In cases where we think the impact is transitory in nature and not a permanent challenge to the prospects for the company, we think it can provide for a compelling investment opportunity. We tend to avoid stocks that we view as more short-term trading oriented, speculative, or those highly dependent on cyclical or commodity exposures.
So far this year we have seen a significant sell-off in many of the growth areas of the market that had led the equity markets in recent years. Part of this can be explained by rising interest rates, growing concerns about a recession, a rotation centered on a “return to normal” and commodity stocks. As is often the case in periods of dislocation one can find interesting opportunities, especially if one has a longer-term orientation.
Asset allocation between stocks and bonds is perhaps the most important decision in determining returns and volatility.