Economic Commentary – Q1 2022

Quarter in Review

• Russia’s invasion of Ukraine has upended the global economy and has added another complexity to the ongoing inflation problem.
• Equity markets closed the quarter on a positive note in March but were still negative for the quarter. Energy was far and away the best performing sector during the quarter due to the uncertainty in the energy complex caused by the Russian invasion.
• Bond returns were weak due to continued worries over persistent inflation and the shift in the Fed’s rhetoric to a more hawkish stance.


Pivotal events in the first quarter of 2022 help explain why both bond and equity market returns experienced setbacks for the period. First, Russia’s invasion of Ukraine has upended the global economy and extend-ed the inflation problem. Next, the Fed shifted its rhetoric to a more hawkish stance in light of the war and its effect on inflation. Lastly, the pandemic’s re-surgence in China continued to stymie efforts to im-prove the flow of goods.

The war now underway in Europe is pivotal since it abruptly ended Russia’s role in the global economy. In the words of The Economist magazine, Putin’s inva-sion is “a nail in the coffin of globalization.” The broad sanctions and swift co-alition against the invasion promise to have long-lasting implications for energy policy, supply chains, and a host of other issues beyond the scope of this piece. The global supply chain problem was intensified by this action since so many vital commodities are affected, all of which will surely extend the inflation prob-lem. This unfortunate set of conditions has triggered a decidedly more hawkish tone from the Fed, which began a tightening campaign by increasing its policy interest rate on March 16 by 25bps (0.25%). Subsequent comments by Chair Powell and other Fed officials suggest an increased likelihood that one or more of the upcoming rate hikes will be 50bps, soon to be coupled with quantitative tightening whereby the Fed will begin reducing the size of its balance sheet. Other central banks around the world will be acting in concert with the U.S. in order to combat the pandemic-induced (and subsequently geopolitically-exacerbated) inflation.

If the global pandemic didn’t lead to changes in thinking regarding supply chains, the sudden onset of war undoubtedly has. Any multinational company that had previously operated with just-in-time inventory practices will almost certainly be inclined to maintain higher levels of various inputs due to the in-creased threat of shortages. Ultimately, this type of change could erode corpo-rate profit margins across a range of industries. And even though the energy intensity of developed economies is lower today compared to previous episodes of high energy prices, the risk is rising that a negative feedback loop from steep-ly higher energy costs will be put in motion and felt more acutely.

Beyond obvious offenses such as Russia’s invasion, other kinds of conduct of foreign nations will be under growing scrutiny by the investment community now that the war has awoken many to this kind of abrupt turn by an autocratic re-gime. As The Conference Board noted in a recent paper, “multinationals need to deeply rethink their global footprints as trade and economic policies shift — a process that will take years but is surely starting now.” Their report calls out “fragmentation” and newly developing trade blocs that are likely to emerge from this heightened sensitivity to and understanding of ESG issues. Again, this type of change in supply chains will be more likely to increase than to decrease costs.

Before geopolitical risk reared its ugly head, the U.S. economy was expected to grow at an above-trend pace, albeit slower than last year. Recent economic reports show strong growth continuing but mounting headwinds may slow the pace further than we expected. In addition to high inflation, the increased uncertainty stemming from the Russian conflict could serve to temper corporate investment spending plans and reduce consumer discretionary outlays. Similarly, the higher prices on a host of goods may change or delay investment plans, just as the higher prices for goods or services tend to lead to some demand destruction on the part of consum-ers. These kinds of changes may seem small and idiosyncratic at first, but over time they tend to build into observable trends that markets cannot ignore. All of this leaves us more concerned about next year’s pace of growth and we believe a mild recession is becoming more and more likely in 2023 or 2024.

With all sorts of things changing rapidly, it does not come as a surprise to see divergent performance across sectors and styles in the equity market. Value stocks, which have suffered from a prolonged period of under-performance relative to growth stocks, performed comparatively well in the first quarter, albeit still slightly neg-ative. As well, the technology sector lagged due in part to mounting concerns about the outlook for GDP growth, while the defense sector rallied due to the war and its implications for increased spending on all sorts of things: fighter jets, ships, missile defense systems, and more. The energy and materials sectors also per-formed well as one would expect given the big rally in energy and other commodities, and the war also under-scores just how dependent much of the world is on fossil fuels despite the desire to adopt green sources of en-ergy. Lastly, both developed and developing international stocks lagged U.S. stocks for the period. With so many of the war’s impacts being felt more acutely by foreign countries, this outcome is logical, and it also brought to lighten certain vulnerabilities of countries and companies that were overly reliant on one country or region for critical products.

Pivotal changes in sourcing strategies, geopolitical risk, and prices for various commodities — all coming to-gether in one quarter — that’s a lot for anyone to absorb. Our investment approach of investing with a long term view is also being tested by these newly turbulent waters. So far, the kinds of resilient companies we in-vest in — both in equities and fixed income — appear to be on solid footing despite the pivotal change under-way. That may or may not persist, but we remain hard at work to determine what changes, if any, might be warranted with all the developments described above.

Of course, the war may end as suddenly as it started and, if regime change occurs, Russia could be welcomed back into the club of law-abiding nations. Unfortunately, Russia’s actions and the rising tide of outrage over its soldiers’ atrocities seem to be pointing to a more prolonged affair with long-lasting consequences. Regard-less, changes emanating from this action and the repercussions for supply chains will likely be permanent and take years to fully play out.

We will close by expressing our solidarity with the people of Ukraine and our hope for a swift end to the fighting.