It seems like we have all been on a journey over the last few years, enduring the seemingly never-ending challenges of a global pandemic and its impact on our lives and the economy. As Covid-19 spread in early 2020, the US and many parts of the world entered unprecedented physical lockdowns. Not surprisingly, this created a tremendous strain on the economy. Two years later, we are still seeing these economic impacts. Rest assured, the investment team at Marshall Financial Group regularly monitors the equity and fixed markets in addition to other economic indicators. Based on these indicators, we believe the economy remains strong.
The Overall Picture and Recession Risks
Economic indicators help financial professionals think about current and future investment growth. Of the twelve recessionary indicators, two have recently changed. Wage Growth has moved from a caution signal to a recession signal and Money Supply is now showing signs of caution. However, as you will see in the chart below, the remaining ten indicators continue to indicate expansion.
For perspective regarding current economic indicators, the chart below summarizes the status of these 12 economic indicators during several previously notable economic periods. There are more green arrows indicating expansion currently than there were in 2020 and during the 2007-2009 financial crisis.
Government Stimulus and Spending
Since the beginning of the pandemic, the US government has provided a wide range of stimulus relief to aid in the recovery for individuals, businesses, and the economy. The fiscal response during COVID has been 9 times bigger than during the 2007-2009 financial crisis. Although this stimulus was implemented to maintain economic stability during the pandemic, we are now challenged with increasing inflation and labor challenges.
Rising Inflation and the Federal Reserve
Although 10 out of 12 economic indicators remain positive, the impact of increased consumer demand following lockdowns, government stimulus expenditures, and supply constraints have led to higher inflation than we have experienced in the last 40 years. In the graph below (provided by the St. Louis Fed) you will see the recent historical CPI.
The Federal Reserve is now systematically decreasing the amount of assets it is purchasing each month, which is known as tapering. This activity reduces the amount of stimulus money being supplied to the economy. This signals that the economy is doing well enough that the Fed believes they no longer need to provide support.
The level of inflation during 2021 was an important factor in this decision by the Federal Reserve Board. We believe that inflation will remain present, however the possibility exists that it will slow from the current level. It is important to note that 2021 inflation levels have been measured against 2020 CPI levels which represent a unique year due to the pandemic. In 2022, inflation will be measured from the 2021 CPI levels. Fannie Mae recently expressed that inflation (CPI) could go to “3.8% by the end of 2022 under our forecast path to monetary policy.”
The Federal Reserve also has indicated plans to increase interest rates in 2022 as inflation continues and we approach the target goal for full employment. Goldman Sachs is predicting the Federal Reserve will raise interest rates four times this year and could begin as early as the taper finishes in March 2022.
Growth in the Equities Markets
The overall economy and specifically the equities markets have not only rebounded from the contraction in early 2020,but experienced an exceptional rate of growth in 2021. The markets in 2022 are demonstrating increased volatility as the economy transitions to a more “normal” rate of growth and efforts are implemented to reduce the ongoing impact of inflation.
Although we are moving toward higher interest rates in the near term, we remain positive for the equity markets for long term investors. The graph below illustrates real returns (after adjustment for the impact of inflation) for different asset classes since 1802. Although stocks are the clear winner, we are committed to developing well diversified portfolios. These portfolios include stocks and other asset classes that align with each client’s goals, time horizon, and risk tolerance.
The markets have recently experienced increased volatility due to uncertainty regarding the economic path forward and its impact on equities and fixed investments. We believe the overall economy continues to remain strong and currently is not showing signs of an impending recession. Although change is ever present, we continue to monitor economic conditions and market opportunities to make strategic portfolio decisions for our clients.
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