I am old enough to remember the 70’s, when gas lines were common, and inflation was eating away at earnings. Unfortunately, the current global economic situation is looking more and more like a rerun from that era. Inflation, already at the highest levels in decades at the beginning of the year, has been made worse by the Ukraine crisis. At the same time, growth which had been soaring, has come crashing down, smothered by high oil prices that funnel dollars away from consumer spending and business investment. The Atlanta Fed GDPNow forecast for the first quarter of 2022 is barely positive. There is a word for an economy that has stagnant growth and high inflation – stagflation. Unfortunately, it appears that it has returned.
We were hopeful that inflation would moderate by mid-year, but as commodity prices continue to soar that outcome seems less and less likely. Annual inflation accelerated to 7.9% in February, the highest level since January of 1982. Energy remained the biggest contributor at 25.6% increase (gasoline rose 38% year over year). But energy was not the only factor as inflation accelerated for shelter, food, new & used vehicles. Excluding the volatile energy and food categories, the consumer price index rose 6.4%, the most in 40 years.
A record 68% of small businesses are raising their average selling prices according to a National Federation of Independent Businesses survey released this week. The average price of a gallon of gas rose above $4 per gallon and may rise above $5 by the summer driving season. For those of us in California the average price already rose to $5.7 per gallon per AAA and may rise to $7 per gallon by summer. In Europe, which imports a major portion of their oil and natural gas from Russia, the impact to the economy is even worse.
Both the stock and bond markets are down for the year, though bonds remain much more stable. Ironically, corporate earnings expectations are still high as companies retain the power to raise prices in the face of rising raw materials costs. It is not clear how long that pricing power will last, but jobs are plentiful, and Americans do still have large amounts of cash to spend and corporations are still making money and that is a good sign.
These are the times to have a well-diversified strategy, and a strategy that focuses on companies with strong fundamentals. We have allocated a large portion of our portfolios to protective positions and are overweighting those companies with strong fundamentals. While this year is shaping up to be a difficult year, we are confident that disruption also brings opportunities for the patient, long-term investor.