Over the last few months, market volatility has dramatically increased. The CBOE Volatility Index or VIX, created by the Chicago Board Options Exchange, is a real-time market index representing the market’s expectations for volatility over the coming 30 days. The VIX started the year at just over 17 and has already reached over 28 during 2022. Several factors can impact the VIX, but generally, any increase in the measurement is closely associated with increased fear and uncertainty in equity markets.
The markets over the last three weeks have been rightfully focused on the Russia-Ukraine situation, but if we look closer, there are far more factors at play. As we note below, each issue is laden with some amount of uncertainty; progress or lack thereof in each of these developments will likely drive daily market behavior.
Russia-Ukraine
No doubt, this is the most important issue facing the world today. It is not at all clear how far Vladimir Putin is willing to go in his efforts; the length and magnitude of this conflict will be felt worldwide as it plays out. Since the conflict started, the markets have been bouncing around after digesting each piece of news.
Inflation
Inflation has been the headline story for months and we believe it likely will for the foreseeable future. For the first time in many years, we are also experiencing wage inflation, a key factor we believe needs to be present for more broad measures of inflation to remain elevated.
Post-COVID growth rates
As the COVID Omicron variant showed signs of dwindling, there was a strong indication that economic growth would be strong for the remainder of 2022. Domestic equity markets performed well in 2020 and 2021 and we believe much of that performance has to do with the expectation that post-COVID growth rates would be quite strong. We will now be paying close attention to consumer and business behavior considering Russia’s actions and elevated global energy prices.
Energy Prices
Each of these detailed issues is not created in a vacuum. Russian aggression has had a meaningful impact on the oil process but the price per barrel started markedly increasing in November of last year but has been trending higher since the beginning of COVID in March 2020. It is anything but ideal that this upward trend is paired with a conflict that directly impacts the global supply of oil. This summer was expected to be the first “Pre-COVID-like” year, as the pent-up demand for travel is unleashed. However, consumer behavior is likely to be impacted if energy prices stay elevated throughout the summer.
Supply Chain
We believe the supply chain issues impacting almost every industry have had a key role in product prices continuing to rise. Certain supply chains (i.e. Microchips) continue to be sluggish and are not likely to reach equilibrium until sometime in 2023 at the earliest. The COVID shutdown impacted this area of the global economy in a way very few predicted, and the healing is going to take some time. Economists will be closely monitoring how an improved supply chain might help slow the pace of inflation.
Market Valuations (Growth vs. Value)
All of the above-listed issues are generally economic headwinds for certain areas of the stock market. Before the recent market pullback, and over the last two years, technology and other growth sectors have provided market leadership. However, as interest rates have increased along with inflation, we have seen many technology names dramatically sell off, with more positive attention paid to value areas of the market. A post-COVID economy is likely to look quite different than the last two years, and recent market behavior is telling us that elevated market valuations are being punished when corporate earnings and outlook lack adequate support for their respective valuations. Although we never cheer certain stocks selling off, we find this recent change constructive for healthy market conditions more favoring fundamentals over stories.
To be an informed investor, one must remain cognizant of the economic issues at play. There will never be a day where the word is absent of concern, but we also know that scarier periods are never permanent. We believe investors will best be served by maintaining a long-term approach and not letting the emotions of an uncertain period drive decision-making.
If your investments are long-term, you should be thinking about them with a long-term approach.
- Diversification can be overdone – there is a point where adding another investment to your portfolio can be harmful to the risk/return profile
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