Let's build a country of opportunities, where everybody is equal before the law and where the rules of the game are honest and transparent, and the same for everyone. ~ Volodymyr Zelensky, President of Ukraine
I prefer peace. But if trouble must come, let it come in my time, so that my children can live in peace. ~ Thomas Paine, American Revolution era-author of the Common Sense and Crisis writings (1737 - 1809)
On the economy
While the world worked to heal itself from the economic trauma of the Covid-19 pandemic, a number of new headwinds came on the scene, namely Russia’s invasion of Ukraine. Russia’s actions have unleashed a sharp rise in commodity prices, destabilization in Europe and a humanitarian crisis, all of which are having a ripple effect on the rest of the world. The war between these two countries has raised the uncertainty for the growth in the U.S. for 2022 as well as in the rest of the world. The Organization for Economic Cooperation and Development (OECD) estimates that the global economy will only grow 3.5% instead of 4.5% in 2022. Countries with close trading ties to Russia will have the biggest slowdowns as will poorer nations, particularly in Africa, which heavily relied on Ukraine and Russia for much of their wheat and maize supply. No country will suffer as much as the two at war though.
Declining growth will be coupled with rising inflation, as much as 2.5% higher than it would have been absent an invasion. As OECD Chief Economist Laurence Boone said, “If you look at commodity prices, it’s going to affect every single consumer on the planet.” The critical supplies of oil, precious metals and agriculture, primarily wheat, that are exported from Ukraine and Russia are now unavailable or unwelcome and the pressure on other countries to make up the scarcity, is adding to price increases.
If the Ukrainian situation was not widely expected, the headwind from the Federal Reserve was; that is the lifting of the Federal Funds interest rate after two years pinned at zero. In March the increase by 0.25% was met with almost a sigh of relief. Many felt the Fed was already well behind on its obligation to control inflation, which clocked in at nearly 8% annually through the end of February, and would need to run, not walk, to rein it in. The Fed has been talking about its plan to raise rates for months, almost like a child repeating a mantra so that everyone who hears can hold them accountable. Determined to accountable, the Fed has signaled it will continue to raise rate at each of the next six scheduled meetings in 2022.
The goal is to slowdown the economy by pushing the rates to 2%, if not higher. Borrowers are already paying more in interest on everything from credit card balances and new mortgages. Consumers and businesses have begun responding by holding off on non-essential spending, unless it is on services such as travel and entertainment. As goods demand declines, prices will eventually fall back into a familiar range, the effects of the war notwithstanding. The math looks good on paper because rates are too low and prices are too high. And given that Covid-19 is no longer wreaking (as much) havoc on businesses, the official unemployment number is under 4%, and, as we keep hearing, the consumer is strong, the economy looks able to withstand tightening.
The Fed has raised rates eight times in the last 42 years. Six times the process ended due to a recession, although not entirely because rates were higher. In 2000 the dot-com bubble burst; in 2007 housing prices burst and of course in 2020, the Covid-19 virus reached pandemic portions. But in none of those times was inflation this high except for the early 1980s in the era of Paul Volcker, the Fed Chairman from 1979 – 1987. Chair Volcker had to deal with high unemployment, 6-10%, and soaring inflation, 6-13%, during his term. He lifted rates as high as 20% but found it was not enough to dampen inflation. So Volcker turned his focus to tightly controlling the money supply, which was done by buying and selling securities so only enough liquidity was available for the most pressing needs. Under this method, inflation dropped below 5% and unemployment below 8%.
Our Fed has stopped adding liquidity by buying securities, which it had been doing since the start of the pandemic, but it has not yet begun selling any from its massive and bloated account. Doing so would not delight Wall Street but would accelerate the decrease in inflation, despite impacts of the Russian invasion.
To paraphrase the Fed’s actions, and appropriate a popular saying about Facebook’s management in the early days, the Fed is going to move fast and probably break things. At the very least, it is going to tighten monetary policy until it hurts.
Globally, other countries with the same runaway inflation problems, are facing their own upheaval. Peru issued a curfew in the capital Lima to stifle violent protests by workers with fixed salaries. Sri Lanka’s government ministers have been resigning amidst food shortages, electricity cuts and long lines at petrol stations. Kenya has also seen long lines at the pump and delayed a much-anticipated subsidy payment to oil-companies that keeps prices down for Kenyans. Turkey’s inflation has jumped to 61%. Zimbabwe has lifted its central bank interest rate to 80%, from 60%, to stem inflation and currency decline; the country uses the U.S. dollar for many transactions and as the U.S. lifts rates, it causes deprecation in the Zimbabwean dollar, a delicate relationship that is mirrored in many stressed emerging economies.
On the markets
March Madness, the college basketball tournament, not the world’s sentiment last month, provides us with a helpful good adage that investors seem to be exhibiting – survive and advance. While last quarter’s stock market was extremely challenging
, it did not chase away participants, who survived but struggled to advance. All of the three major stock indices, the Dow Jones, S&P 500 and Nasdaq, were solidly in the red through March 31st. Amongst the different sectors, energy was the only standout and best performer, albeit due to supply shock worries as buyers of Russian oil boycotted the trade after Russia’s incursion into Ukraine on February 24th.
Rallies higher in stocks have been short and unsatisfying with the downturns a bit longer and bitter. The research firm CFRA recorded 30 days of the first 61 trading days in which the S&P 500 moved more than 1% during the regular trading session. Even for a market that has become very reactionary with the advent of algorithmic traders, think robots driving prices instead of humans, last quarter was a monumental amount of volatility. That is not normal nor do we want to see more of that sort of action. It causes investors to second-guess, make impulsive moves and panic. But volatility may be here to stay this year.
As stocks dropped around the world too. Europe, with a front row seat for the Ukrainian invasion, was able to stage a late March comeback to stem a bit of the losses. Still money is fleeing the region as worries about slower growth and stagflation, the persistence of high inflation and low employment, is dogging investors.
Throughout, the bond market has not been the usual refuge to protect money from stock trembles. Understandably a rising-rate environment makes bonds, at risk of principal loss, unappealing. An aggregate bond index of U.S. Treasuries, high-grade corporate bonds and mortgage-backed securities lost 5.9% last quarterly, the biggest quarterly loss since 1980. During the same period, the benchmark 10-year Treasury bond yield has soared from 1.52% to 2.35%. Remember that bond yields and prices have an inverse relationship; prices fall as investors sell, increasing the yield. For those who will hold bonds until maturity and are happy for the interest income, the declines should not be distracting.
For now, the volatile stock market will be seen in some cases as the only alternative for investors. That is because real rates remain negative. Real rates, the return that an investor receives after accounting for inflation, have been negative since the beginning of the pandemic. Bloomberg charted the real yield on 5-year Treasury notes and even after the Fed rate increase, yields are deeper in negative territory than even the beginning of the year. It is only one piece of a complicated puzzle, but does account for some of the stock market rallies.
On personal finance
As we think daily about how much the price of most everything has flown up, the same is true on an item that has always been costly – long-term care. Per the Health and Human Services department, 70% of people turning 65 will need some sort of long-term care, provided either by a facility, an in-home assistance or family. Only 15% will spend two or more years in a health care facility for around-the-clock care. Women make up nearly 70% of the patients in facilities and they stay longer than men, on average 44 months versus a man’s 26 months.
The role of Alzheimer’s dementia in this equation is big – it impacts more women and causes more families to turn to skilled medical care than other chronic diseases. At a time when deaths from heart disease have been falling, deaths from Alzheimer’s increased 146%. It lasts usually eight to ten years with symptoms that only intensify over time. Because of the length of the disease and the cost of getting professional help, it is estimated that 11 million Americans are providing unpaid care to a loved one right now; the value of this is roughly $272 billion. The economic costs are staggering. Not to mention the mental and physical stress on families.
For many thinking ahead, planning for health care costs in their retirement is the one of the most expensive pieces of the budget. Health care costs have always outpaced the regular rise in inflation, making it especially tricky to estimate regular care for retirees, not to mention a catastrophic illness. Fidelity Investment’s long-running survey recommends that a couple have $300,000 in after-tax savings to cover the usual expenses. Note that this “does not include other health-related expenses, such as over-the-counter medications, most dental services and long-term care”.
However, preparation for long-term care does not necessarily mean purchasing insurance. As long-term care policies have evolved and aged, the number of insurance providers has declined. Premiums have been increasing on policy-owners, who generally pay thousands a year as it is. Per the American Association for Long-Term Care Insurance, in 2022 a 65-year old couple could expect to pay $3,750 combined in premiums a year for $165,000 of future benefits. If the future benefits are inflated by three percent annually, premiums nearly double to $7,150 combined. Because a policyholder does run the risk of never needing or using the benefit, many policies sold today are hybrid plans with life insurance or, less often, an annuity, linked to it.
It is understandable why one with sufficient means for retirement would want to assume the costs themselves. Considering the likelihood of needing care, discussing the alternatives to outside assistance, ball parking the cost and determining what assets could be set aside for help all take time to unravel. If you need help, please let us know. Serene Point Advisors does not sell any insurance but we are always happy to guide clients in discussions about how to tackle this important part of life planning.
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