In a marked contrast to results over the last three years, the stock and bond markets each ended the first quarter decidedly lower. In the U.S., large company stocks were down 4.6% and smaller companies were down 7.5%. Foreign stocks were down 5.9% and bonds were lower by 5.9%. The volatility during the quarter was brought on by a slowing global economy, the anticipation of rising interest rates and military conflict in Ukraine.
The world is witnessing the suffering and destruction of war as Russia made good on threats to invade its neighbor Ukraine. The human toll of the conflict has been immeasurable, though we remain hopeful for a viable resolution in the near future. The war is happening both on military and economic battlefields. Russia is strong militarily, though comparatively weak economically. The strategy of economic sanctions from the West is proving a potent tool in exploiting this vulnerability. Indeed, there are initial signs that the sanctions are having a damaging effect on the Russian economy. Russian government-issued bonds are now priced at less than a quarter of face value. As of this writing, none of the funds in Natural Investments model portfolios hold any Russian stocks or bonds.
The hostilities are unfolding against a backdrop of faltering economic recovery in the U.S. and around the world. The economic growth rate in the U.S. for the first quarter slowed markedly from last year’s well-above-average rate of nearly 6%. Even with the slowing economy, U.S. inflation jumped to a 40-year high in January of 7.5%. Inflation normally accompanies accelerating economic growth, so its appearance now is something of an anomaly and sets up the prospect for what economists call “stagflation,” a term for a slowing rate of economic growth coupled with high inflation. Unemployment levels can increase when the economy slows, which makes rising prices particularly troublesome for many.
In an effort to combat rising inflation, the Federal Reserve Board raised the federal-funds rate in mid-March by a quarter point. We’ll likely see several additional rate increases this year, and further increases in 2023. The Fed is in a difficult position because rate increases can also have the effect of slowing the economy. The economy is slowing already and too much slowing may result in economic “stagflation” as mentioned above, or even recession (economic contraction.)
Gasoline prices hit record highs in March, which sparked criticisms of President Joe Biden’s energy policies. However, many analysts believe the primary reason for rising gasoline prices over the last year has been the coronavirus pandemic and its disruptions to supply and demand. In the early months of 2020 as the virus emerged, business and travel ground to a near halt, demand for gasoline dropped significantly and prices fell. In response, oil companies around the world cut their production. As pandemic conditions began improving and world economies reopened, demand outstripped supply and prices began to rise. Now the Russian invasion of Ukraine has compounded the situation by further threatening global supply.
The surge in oil prices past $100 a barrel has raised a big question—will this latest spike in oil prices help to speed the global transition to low-carbon energy sources? On one hand, energy analysts say, soaring prices for gasoline and other products made from oil may drive consumers to adopt electric vehicles and appliances more quickly, and may encourage public support for investment in renewable energy infrastructure. Nonetheless, high oil prices will also drive oil companies to increase production in the U.S. and abroad as they rush to cash in. This added supply may bring oil prices down, thus making oil companies more cost-competitive with renewables again. While pricing advantages are a plus for renewables when they occur, we continue to believe that a durable shift to renewables will be based less on pricing fluctuations and more on public demand and political will.