When Does the Song Change?


When we all look back at our quarterly notes written throughout 2022, there will be a common refrain. It is as though the finance world decided to take a page out of the music industry's book by recycling a melody with only slight variations. This is our third quarterly commentary this year, and we have also put out a few other market updates, yet all sound out three major chords – inflation, the Fed, and volatility (and basically in the same order).

Echoing past quarters, 2022 continues to be one of the worst starts for a balanced portfolio in modern history. U.S. Bonds are suffering one of their most difficult years since before Paul Volker (think 1979). With stocks down more than 20%, a conservative portfolio is not doing that much better than an aggressive one. This is not only a U.S. phenomenon. We see comparable and often more dire performance overseas in dollar terms. In short, this is an incredibly challenging environment for all investors that demands a level of patience that is hard to maintain in the face of constant headlines. Like we did during the 2016 sell-off, Brexit, U.S. elections, COVID-19, and other trying periods, we hope to provide context around why this is happening, emphasize the importance of avoiding knee-jerk reactions, and highlight potential opportunities ahead.


In our Q1 letter, we talked about the Fed and bonds. In Q2, we focused on inflation. In those, we covered how inflation got to this level, a sequence of: COVID-related manufacturing closures and supply-chain bottlenecks, trillions of stimuli looking for a place to go in an economy that is nearly 70% consumption, shrinking labor force participation and a corresponding growing need for workers (thus wage growth), low housing supply, continued zero COVID shutdowns in China, and eventually the war in Ukraine.

At the same time, the Fed dropped interest rates from around 1.5% to zero in March of 2020 and kept them there for almost two years despite inflation shooting up through much of 2021 (hitting 7% YoY in December 2021). As a reminder, the Fed has a somewhat convoluted mandate or purpose “to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.” The tagline in 2020 and 2021 was that inflation would be “transitory”. This proved to be true for the early offenders (rolling over lumber prices, shipping costs, used cars, etc.), but other “stickier” components eventually started to rise. Coming into the year, the Fed looked like it was losing inflation-fighting credibility. In fact, markets were pricing in just three 25 bps rate hikes for 2022 at the start of the year, which translated into the Fed Fund rate being below 1 by the end of this year.