Economic Crossroads - 1st Quarter - 2022

Economic conditions are in flux across the board, from inflation and rising interest rates to the strong possibility of slower economic growth. Considering this, and after seven straight quarters of solid returns, we are not shaken by the recent pullback in global equity and fixed income markets. Global stocks declined 5.3%, while US bonds fared even worse with a 5.9% pullback. Investors are adjusting to a new outlook.

The Russian invasion of Ukraine amplifies the uncertainty. Disturbing on many levels, the conflict’s political, social, economic, and humanitarian impacts are far reaching and ongoing. This event (and others like it over the years) calls into question economic globalization, a hallmark of the modern era. Over the decades, specialization and outsourcing have grown dramatically and local markets are now often dependent on distant ones. Productivity has benefited greatly from this trend and, as such, incomes and opportunities have improved for a large portion of the world’s population. We are all now witnessing the downside of global interdependency. Procuring goods and services from the lowest cost providers may give way to a desire for greater reliability and redundancy. This will only happen, however, with new technologies and if we are collectively willing to pay a premium for it.

The heightened cost of energy today has far more to do with geopolitical events than supply; it’s all about sourcing. As of 2019, 90+ million barrels of oil were consumed daily around the world. Russia produces 11 million of them, of which 7.5 million were exported, making it the largest sources of hard currency for that country. With most nations now shunning Russian oil, in the short-term, the price of oil has risen to reflect the costs involved in making that logistical adjustment. Although oil is currently trading north of $100 a barrel, the futures price three years out is $70. Adjusting for inflation, oil now costs about the same as it did back in 1982 ($35 per barrel).

With unemployment rates at 60-year lows, labor too is adding systemic pressure to the cost of goods and services. There are many factors that have led to the current labor challenge. Promoting immigration is one answer that could go a long way in alleviating this problem.

Though interest rates are widely anticipated to rise over the remainder of the year, the absolute rate is still low in nominal terms. Markets expect short rates to climb back to 2% in one year, but long-dated rates are not materially higher, supporting the notion that inflation will not spiral out of control for years to come. Inflation is running hot today and causing economic pain for companies and individuals the world over. However, the conditions present during the 1970s, we believe, are not present today. The Fed’s actions are targeted at preventing a self-perpetuating cycle where high labor costs lead to higher prices and vice versa. Whether the Fed can accomplish this without causing an economic recession is the question.

Productivity gains are at the core of economic success. Products and services that create efficiencies will reward their stakeholders and society. Productivity enhancements are supported by political stability and a strong legal system, and are accelerated by access to relatively inexpensive capital, energy, and labor. There is no question that these inputs have become headwinds for the time being. Investing capital is complex. There are no easy answers. And yet, opportunities continue to exist for the thoughtful investor.

Thank you for your partnership. We look forward to continuing the conversation.