By Deron T. McCoy, CFA®, CFP®, CAIA®
Chief Investment Officer
Inflation changes everything. So much so, that we suggested a year ago that markets might chop around throughout the back half of 2021. In short, our overstimulated economy needed to digest a fairly radical shift in monetary policy—and sure enough, the selloff continued into 2022 after the Fed’s hawkish pivot in early January.
Both U.S. and International equities are now down double digits (-17%) year-to-date, with the real pain concentrated in both Small Caps (-22%) and the Nasdaq (-27%). Bonds (-10%) are also in correction mode with U.S. Treasuries suffering the worst start to a year since the days before George Washington was president!
But selloffs in a growing economy present opportunity! Yes, the latest GDP print was indeed negative, but recall that was Real GDP (after inflation). In nominal terms, Q1 GDP growth was actually quite robust, and corporate earnings are both calculated and reported in nominal terms.
Long-time readers will recall that the primary concern for stock investors in a high inflationary environment was last year’s high Price/Earnings valuations. But with a 16% decline in the numerator (Price) alongside a 6% increase in the denominator (projected 2023 earnings have moved higher), valuations have become much more reasonable. So much so, that the back half of this year now looks to be much more promising. While stocks may continue to chop around here for a bit as investors digest and react to the latest Fed musings, the risk-to-reward ratio (potential upside versus potential downside) appears to be setting up in favor of long-term equity investors.
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