As the Federal Reserve raised its policy interest rate in mid-March and signaled plans to hike it six more times in 2022, a pair of local wealth managers shared what investors can expect from the market.
The Federal Open Market Committee (FOMC) raised the target for the federal funds rate by a quarter percentage point from 0.25% to 0.5% during its March 16 meeting for the first time in three years and signaled six more rate increases in 2022 in the interest of curbing inflation, which reached a 40-year high of 6.1% over the past year, by dampening demand.
Jerome Powell, chair of the Federal Reserve board, said the Fed is tightening its monetary policy because “inflation remains well above our longer-range goal of 2%” while GPD growth, employment and the economy remain strong enough to weather rising interest rates.
“Although the invasion of Ukraine and related events represent a downside risk to the outlook for economic activity, FOMC participants continue to foresee solid growth as shown in our summary of economic projections,” Powell said in a March 16 press conference. “The median projection for real GDP growth stands at 2.8% this year, 2.2% next year and 2% in 2024. The labor market has continued to strengthen and is extremely tight over the first two months of the year. Employment rose by more than 1 million jobs in February, and the unemployment rate hit a post-pandemic low of 3.8%, a bit below the median of committee participants’ estimates of its longer-run normal level.”
He said demand remains strong while supply chain bottlenecks continue to limit how quickly production can respond.
“These supply disruptions have been larger and longer-lasting than anticipated, exacerbated by waves of the virus here and abroad, and price pressures have spread to a broader range of goods and services,” he said. “Additionally, higher energy prices are driving up overall inflation. The surge in prices of crude oil and other commodities that resulted from Russia’s invasion of Ukraine will put additional upward pressure on near-term inflation here at home.”
Powell said the Fed is looking to corral prices now, as high inflation most certainly will impose hardships on households in lower-income brackets.
“We know that the best thing we can do to support a strong labor market is to promote a long expansion, and that is only possible in an environment of price stability,” he said. “… With appropriate firming in the stance of monetary policy, we expect inflation to return to 2% while the labor market remains strong.”
The Fed does not expect its rate hikes to have quick impacts, but projects inflation will fall to 4.3% this year, to 2.7% next year and to 2.3% in 2024, Powell said. He added the Russia-Ukraine conflict could change the situation, but the FOMC is monitoring the situation closely.
Steve Doorn, senior vice president and director of portfolio management at Legacy Trust in Grand Rapids, said “a little bit of inflation isn’t a bad thing,” and the Fed tightening monetary policy usually is a sign of economic strength.
“It means that things have gotten better to the point where the Fed can begin to reduce some of its accommodative policy. It is strong enough to stand on its own two feet and doesn’t need the same level of support that it did in the early stages of the pandemic,” he said.
Doorn said during the historically long economic expansion that started after the Great Recession and continued until the pandemic hit, people who don’t remember the high inflation of the 1970s and ’80s became conditioned to low inflation and thus might be feeling more nervous than necessary as prices rise.
“Some inflation allows companies to increase wages, which generally lifts the standard of living for everybody,” he said. “Where you get into some difficulties is when you get persistent inflation in the 5%, 6%, 7% range. Then, that starts to eat into people’s ability to spend, and one of the things we have to keep an eye on right now is the difference between the level of inflation and the level of wage growth.”
When it comes to portfolio management, Doorn said investors should expect lower returns for bonds and fixed-income investments, as bond prices move inversely with interest rates. He said he wouldn’t be surprised if the overall valuation of the stock market decreased, but earnings growth in the still-healthy economy likely will be strong enough to offset the reduction in valuation.
“Despite the slow start to this year, (stocks) could still have positive returns by year-end,” he said. “… We’re coming off three great years for the stock market, and valuations coming into this year were above average. When you’re in a period of rising interest rates, you expect valuations to contract. We think that a good year this year will be a return on stocks between 5% and 10%.”
Nick Juhle, chief investment officer at Greenleaf Trust in Kalamazoo, said the Fed had long ago signaled this rate increase and the market was pricing for it. Indeed, stocks rose 2% after Powell’s announcement.
He also said regardless of what the stock market is doing, inflation is the main reason people should invest.
“You need to be able to outpace inflation over time, or the money that you’re earning and putting under the mattress today is not going to buy all the things you need it to in retirement,” he said.
“Your options are you could keep all your money in cash with zero risk … but your purchasing power will decline over time, so the value of your dollars would actually go down, which is why it’s important to invest money in the first place, to have a portfolio that’s invested according to your ability and willingness to take risk and also aligns with your long-term financial goals.”
Juhle said he looks at equities, or stocks, as the “first line of defense against inflation.”
“If you look back historically, they have consistently outpaced inflation over time,” he said, contrasted with the returns on commodities such as gold, which tend to track with the level of inflation instead of outpacing it.
He said he tells clients it’s very hard to predict what the stock market will do in any given 12-month period, so it’s best to look at the long run and sit tight.
“You may have a flat year this year … but over a three-year, five-year or 10-year period, the longer out you look, the higher are your odds that equities are worth more over that period than they were when you started,” he said.
“(That) is a great reason to continue putting money away in alignment with your goals and to stay disciplined and not use events like geopolitical conflict and others as a reason to get out of the market as an emotional reaction.”
He recommends investors talk to an adviser to ensure they have a diversified portfolio and the lowest fees and tax liability they can in order to get the best returns.
Juhle said he is hopeful the Fed’s actions to curb inflation will mean people have more discretionary income to invest for their future.