Gill Capital Partners January 2022 Update

As we write our first commentary of 2022, we want to reflect on the many challenges that we faced in 2021, but also look ahead to the optimism a new year brings and wish you all a safe, healthy and prosperous 2022. There is no shortage of topics to discuss; top of mind at the moment are inflation, interest rates and the Federal Reserve, the recent selloff in growth stocks, and labor and inventory shortages. We will get into these issues in more detail and, of course, provide our views on them, but first, a bit of humor.

Inflation, Interest Rates & the Federal Reserve

Just last week we got a much anticipated read on inflation. The official CPI report showed inflation increased by 7% year-over-year and rose 0.5% from the previous month. While this number was largely expected, it still marks the fastest 12-month pace for inflation in nearly 40 years. Interest rates have continued to climb, particularly short-term interest rates, which are now pricing in multiple rate increases by the Federal Reserve in 2022 and 2023. The chart below, courtesy of JP Morgan, shows market expectations and The Federal Reserve’s forecast for interest rate increases over the next couple of years, indicating that the overnight borrowing rate could hit 2% by the end of 2024, up from zero where it sits today.

Our view – On the inflation front, while the 7% headline number is rather shocking, it does not come as a surprise, and must be taken in context as it is looking at year-over-year changes in inflation. While this number certainly represents significant inflationary pressure, we recognize we are capturing price increases in some areas that were still significantly depressed a year ago, and we do not anticipate this pace of growth to continue next year. On the interest rate front, short-term rates have moved up dramatically and are now fully pricing in the Fed’s forecast for the next couple of years. We continue to believe that the Federal Reserve is going to generally do what they say they will do, which, in this case, means they will raise rates 2-3 times this year, and potentially again next year and the year after if the economy will allow for it. We believe that this Federal Reserve will not take an overly aggressive stance, but that they will raise rates. It is important to point out that if the Federal Reserve follows their plan for the next couple of years, the overnight borrowing rate will increase to around 1.5%-2%. This is obviously higher than where we are today, but still not very high on a relative or nominal basis and not restrictive for growth. While the Federal Reserve has indicated they see a case for raising interest rates, they also recognize the challenges facing the economy, such as labor and supply shortages and COVID-related shutdowns. These challenges create a tenuous environment to aggressively raise interest rates, so while we believe that the Federal Reserve will raise rates, we feel the risk in their forecast is likely for lower rates as opposed to higher.

Growth Stock Selloff

One of the more pronounced impacts of the sharp increase in short term rates has been a correction in high growth and small cap stocks, which have fared considerably worse than the major indices. These types of companies, which are generally more highly leveraged and sensitive to overall economic growth, have corrected considerably in recent weeks. As of this writing, the S&P 500 Index is down over 5% from its recent highs, while the tech heavy NASDAQ index is down over 10%. Many familiar names are down dramatically more. Since the inception of the NASDAQ index in 1971, this is the 66th correction of at least 10%. That means that in the 50-year history of the index, on average, a correction of 10% or more has occurred 1.3 times per year.  So, while this current correction may be unnerving, it is not uncommon. Further, while the index may continue to drop, historically, 67% of the time markets have been higher one week, one month and one year following a correction of at least 10%. Investors have been rewarded significantly over the years by having discipline, as the average 1-year return of the NASDAQ following a correction of at least 10% has been nearly 20%.

Our view – We are taking advantage of the selloff in high growth stocks to rebalance portfolios as necessary. We continue to believe in the prospects for innovation coming from these companies, and do not yet view the current interest rate environment as restrictive to the long-term growth prospects of these companies.

Labor & Inventory Shortages

If you have been to the grocery store lately, you have undoubtedly seen bare shelves, conjuring bad memories of the spring of 2020. The reasons for dwindling supply are numerous and may represent a perfect storm of factors including record COVID cases, labor shortages, and weather. The highly contagious Omicron variant has resulted in record numbers of sick employees at grocery stores (and elsewhere), making it tough to restock shelves. This has been compounded by the labor shortage both at the store level and throughout the logistics network. Stores and trucking/shipping companies alike are having an extremely difficult time keeping and attracting employees. This is further aggravating the supply chain that has become dependent on “just in time” inventory management, as supplies are not arriving in time or stores lack the resources to put them on shelves. Finally, a series of weather events throughout the country has been the icing on the cake in a sense, exacerbating an already delicate shipping and trucking situation. These factors have made it impossible to keep up with the modern supply chain management system.

Our view – It really is a perfect storm of issues for stores, and while we anticipate conditions will improve, we recognize that the labor component may continue to be problematic for some time to come. We continue to see workers quit lower paying jobs at a record pace. This will present challenges for employers and consumers alike and will possibly contribute to some level of economic slowing throughout 2022.

As always, please let us know if you have any question or concerns, or if we can provide assistance with any other financial planning matters including education, taxes, insurance or estate needs.