Ukraine Tensions & Fed Policy
The two primary forces affecting markets right now seem to be the Ukraine crisis and Fed policy. Inflation reared its ugly head again last week as the PPI (Producer Price Index) showed that input costs had risen for the 19th consecutive month and more than double analysts' expectations. There is now considerable concern that the Fed is behind the curve on dealing with inflation. To add to those concerns is the trouble going on in Ukraine.
Over the weekend, Russia officially recognized the independence of two territories on the Eastern side of Ukraine that are "separtist" regions. Another area of Ukraine, Crimea, had already broken off from the country in 2014. While the tensions are high, several world governments are proposing sanctions on Russia this morning. So far, markets seem to be handling the tensions quite well as the broad indices are down less than 1%.
Last week, the economic data was mixed as positive news on Housing, Retail Sales, and Industrial Production were welcomed. However, the news on Inflation, Jobless Claims, and Manufacturing were not as positive.
This week we'll get a better picture of the consumer to hopefully bolster last week's surprise Retail Sales report. Corporate earnings seems to be disappointing, not so much on their face, but on their 2022 outlook. It would appear inflation is taking its toll on corporations who have provided negative guidance for this year. With 84% of S&P 500 Index companies having reported so far, stock prices for those companies that have surprised to the upside are up only +0.2%, on average.
We would expect the tensions in Ukraine to ease as invasion does not look like a likely outcome. The S&P 500 Index sold off nearly 6% when Crimea was annexed by Russia in 2014. If we avoid an actual invasion this time around, we would expect markets to adjust. The bigger issue is the Fed.
The difference between PPI and CPI will continue to adjust, likely meaning that we are in for 100-200 basis points of higher inflation until we see a peak. This means the Fed will be forced to raise rates. Over the last 9 economic recessions since 1955, Fed Rate Hiking Cycles have ended in recession in 8 out of the 9 instances. The good news is that the average time between when rate hiking began and when recession resulted was approximately 28 months. For now, equities are still the best hedge against inflation.