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Some reasons for stock market volatility in 2022

High inflation and rising interest rates.

Inflation is growing at its fastest pace in four decades. The Ukraine war is making inflation worse in some areas of our economy. Interest rates are rising faster than they have in over 20 years. [1] We believe that these three factors are greatly affecting the stock markets.

Source:  usinflationcalculator.com.

Source:  tradingeconomics.com.

How does high inflation affect an economy? 

Inflation is the persistent increase in the prices of goods and services in an economy. People and businesses are able to purchase less with each dollar they own. People and businesses must spend more dollars to pay for the same amount of operating expenses. As a result, they cut back on costs wherever possible (restaurants, hiring, etc.). [2]

Inflation causes the dollar amount that a lender lends to a borrower to lose value by the time the borrower pays back the lender. This discourages lenders from lending. Lower purchasing power, higher operating costs, and few opportunities to borrow causes people and businesses to spend less on the economy. As a result, an economy tends to grow slower during periods of high inflation. [2]

How does high inflation affect a stock market?

Investors determine the value, or stock price, of a company based upon that company’s expected future earnings. The higher the expected future earnings, the higher the stock price attributed to the company. High inflation increases the operating costs of a company which can undermine its earnings, and therefore its stock price. High inflation also makes it difficult to gauge the value of a company’s earnings which can cause the stock prices of companies to become volatile. [3]

How is the Ukraine war making inflation worse?

Russia is a major producer of oil for the world. Oil prices have skyrocketed out of concern that Russian oil will become less available either due to western sanctions against Russia for the war or due to retaliation by Russia against the west.

Ukraine is one of the largest grain producers on the planet. The war has hampered all exports from Ukraine, causing global commodity prices to rise.

Why are interest rates rising?

The Federal Reserve is attempting to slow inflation by raising interest rates.

How do rising interest rates affect an economy?

When interest rates rise, the cost of borrowing for people and businesses increases. People borrow less and therefore consume less which slows the growth of local businesses. Businesses borrow less and therefore spend less on hiring and growing their operations which slows down the growth of the economy. [4]

We have adjusted many of our investment portfolios for these reasons

Over the past 12 months, we increased the overall allocation to stocks and introduced a bond fund which may better weather rising interest rates. We added “alternative funds” which are not linked to the bond market and are often less affected by big swings in the stock market as well as invested in commodities which often rise in value with inflation. Finally, we purchased more investments in undervalued companies that tend to perform better during inflationary periods.

Sources:

[1] https://www.npr.org/2022/05/04/1096111642/federal-reserve-interest-rates-inflation-prices

[2] https://hosbeg.com/8-effects-inflation-economy/

[3] https://blog.nationwidefinancial.com/markets-economy/economic-commentary/how-inflation-affects-the-stock-market/

[4] https://www.cnbc.com/2022/02/15/why-the-fed-raises-interest-rates-to-combat-inflation.html


This is meant for educational purposes only.  Information presented should not be considered investment advice or a recommendation to take a particular course of action.  Always consult with your financial professional regarding your personal situation before making any financial decisions.