Breaking insights on the economy, market volatility, policy changes and geopolitical events
In the video above, he offers insights on the competing forces — inflation and slower growth — driving today’s “choppy, saw-tooth kind of markets.” He also provides useful historical perspective and answers key questions the Chief Investment Office (CIO) is hearing from investors.
Making sense of the latest market drop
SO, WHAT JUST HAPPENED? The Dow Jones Industrial Average declined 1,063 points by the end of the day on Thursday and the S&P 500 was down 3.56%. Coming on the heels of a 900-point gain for the Dow on Wednesday, the declines underscored the sharp volatility defining today’s markets.1
Here’s our take on what this means
“The economy and markets are being dominated by a clash of two competing forces — inflation and slower growth,” says Chris Hyzy, Chief Investment Officer, Merrill and Bank of America Private Bank. As a case in point, Wednesday’s gains were powered by the Federal Reserve’s (the Fed) announcement that it was raising interest rates by 50 basis points as a step toward curbing inflation. Yet the drop a day later reflected the market’s deepening concern that the Fed may actually still be behind the curve when it comes to controlling inflation.
“We believe these market swings will likely continue, dominated by news headlines, until we see clear signs that inflation has peaked,” Hyzy says. As it seeks to balance those competing forces, the Fed would likely act quickly by slowing the pace of rate increases, if inflation appears to be dropping too fast. Global uncertainty over the Russia-Ukraine war and extended Covid-19 shutdowns in China are adding to the volatility, he adds. A new Chief Investment Office (CIO) Viewpoint article, “Clash of Competing Forces,” offers a detailed analysis of the current situation and what may be ahead.
What should investors consider right now?
With volatility unlikely to abate soon, investors can look for ways to remove risk from their portfolios, Hyzy suggests. While the CIO’s opinion continues to be a slight overweight to stocks versus bonds, investors might consider a higher proportion of so-called defensive stocks (those that tend to perform better amid turbulence) such as health care and utilities, and a decrease in more vulnerable sectors such as technology, industrials, consumer discretionary and communication services, Hyzy says. “Investors might also consider incrementally lowering their exposure to European equities, given the uncertainties surrounding the Russia-Ukraine war.”
As interest rates — for years stuck near zero — continue to rise, bonds may be worth a closer look, he adds. “The yield for two-year bonds is almost double the current equity yield of the S&P 500,” Hyzy says. “For some investors, bonds are becoming attractive again.”
Yet beyond those specific ideas, “Diversification and a long-term perspective continue to be the top priorities,” Hyzy says. Investors should ensure they have a broad mix of assets within and across asset classes and rebalance their portfolios as necessary.
For more timely insights from the Chief Investment Office, tune in to the CIO’s “Market Update” audio cast series.
Navigating today’s volatile — but resilient — markets
SEESAW PLUNGES AND REBOUNDS in recent days highlight one of the most challenging and unpredictable market environments in recent memory. “It’s well known that markets, especially for riskier assets such as stocks, don’t like uncertainty,” notes Chris Hyzy, Chief Investment Officer for Merrill and Bank of America Private Bank. “And rising inflation and interest rates, the Russia-Ukraine war, COVID-19 lockdowns in China and other factors have created very high uncertainty,” Hyzy says.
On top of those pressures came Thursday’s news that U.S. GDP shrank by 1.4% during the first quarter of 2022, the first such setback since early 2020.1 Yet even so, the economy remains resilient, Hyzy believes. “Job growth continues at a healthy clip and consumer spending remains vigorous.”
In such an unpredictable environment, “Even if near-term trends look treacherous, staying in the market is the most important thing,” Hyzy says. “This uncertainty, even in the face of sudden downdrafts, does not change the principles of asset allocation and the benefits of long‐term investing and diversification,” he notes in “Uncertainty at Its Highest,” a new Investment Insights report from the Chief Investment Office. Here, Hyzy offers insights and steps investors could consider.
Wanted: A turning point on inflation
“Choppy markets are likely to continue until signs emerge that inflation has peaked, which we expect may happen in the second half of the year,” Hyzy says. To counter inflation, the Federal Reserve (the Fed) has sharply reversed its accommodative policies of near-zero interest rates and is likely to raise rates multiple times in the months to come. Still, the economy risks stagflation (a combination of rising prices and a stagnating economy) if the Fed’s efforts are unsuccessful; and, while Hyzy believes recession is unlikely this year, that, too, remains a risk.
For those reasons, investors may want to strengthen their portfolios against two forces at work today: volatility and inflation. “This is a new market regime that may require some adjustments to your portfolio,” Hyzy notes.
Seeking quality and potential inflation protection
Because volatility is inherently unpredictable, investors should ensure that their portfolios are well diversified, both within and across different asset classes, Hyzy says. “Market gyrations in the coming weeks could provide opportunities to become even more balanced in your portfolio.”
High-quality investments also tend to hold up better during periods of elevated volatility. “That means large, well-run companies with strong balance sheets, healthy cash flow and consistent dividend growth,” he adds.
To help protect your portfolio against inflation, you might consider industries that are able to pass along higher prices to their customers, Hyzy suggests. “We also continue to emphasize areas such as energy and U.S. equities relative to the rest of the world.” Investors may also want to consider the financial sector, which typically benefits when interest rates are rising.
Adding some real assets, such as commodities or real estate, could also be considered, since these assets tend to rise with inflation, Hyzy notes. And for bond investors, “We are beginning to witness some attractive yield levels.”
The virtues of a long-term view
Any decisions should be made in the context of your personal, long-term investing goals, Hyzy notes, adding that buying or selling out of fear or in hopes of timing the market are never good strategies. Investors may also be wise to avoid obsessively following the daily ups and downs, Hyzy adds. “The best approach is to stay invested and let the latest market challenges work themselves out over time.”
For more insights, watch “The Big Shift: New Market Forces and Ways to Prepare” and tune in to the CIO’s “Market Update” audiocast series.
2023 budget offers hints of possible tax reform to come
AMONG A HOST OF TAX CHANGES called for in the Administration’s March 28 fiscal year 2023 budget proposal, the “Billionaire Tax” captured the most headlines. But a variety of other proposed changes could affect the returns of a far broader group of tax payers.
“There’s no certainty that these new taxes, designed to generate $2.5 trillion over 10 years, will ever come to pass,” says Mitchell Drossman, head of National Wealth Strategies in the Chief Investment Office (CIO) for Merrill and Bank of America Private Bank. After all, the $1.6 trillion Build Back Better bill, with its own tax increases, stalled in Congress last December. “For now these are only budget proposals, not even legislative proposals,” he notes, and an evenly divided Congress approaching mid-term elections is unlikely to act soon. “Still, these proposals provide insight into the Administration’s tax-reform and deficit-reduction goals, and some could be incorporated into future compromise legislation,” Drossman says.
Below are some highlights and their implications. For a full rundown, see the CIO’s recent Tax Alert, “Income and Transfer Tax Proposals in Administration’s Fiscal Year 2023 Budget.” “You may want to discuss these ideas with your tax professional and financial advisor as part of your long-term planning,” Drossman notes.
A higher top marginal tax rate
One key proposal would raise the top marginal income tax rate to 39.6% from the current 37% on taxable income over $450,000 for married couples and $400,000 for single taxpayers. This proposal would essentially restore the top rate prior to the Tax Cuts and Jobs Act of 2017, and thus it may be likelier to ultimately be enacted, Drossman believes. It would raise an estimated $187 billion.
In addition, preferential capital gains and dividend rates (currently topping out at 20%) would be eliminated for married couples and single taxpayers with more than $1 million in taxable income. This measure, along with the proposed change below, would raise $174 billion.
Tighter estate, gift and GST tax regulations
The budget also proposes tightening many of the rules by which families pass down wealth to next generations. For one, transfers of appreciated property, whether through gifts or as part of an estate, would be taxable to the donor (or the deceased’s estate) at the time of the transfer. The proposal would also limit the duration of generation-skipping transfer exemptions (a popular means of handing wealth down through multiple generations) to no more than two generations.
About that proposed ‘Billionaire Tax’
If enacted, it would place a 20% minimum income tax on those with a net worth above $100 million, fully phasing in at $200 million, and take the unusual step of taxing unrealized gains. “Current tax law imposes a tax only on recognized gains, with very limited exceptions,” Drossman says, meaning an investor who buys a stock for $1,000 and sells it a decade later for $10,000 owes a one-time tax on the $9,000 gain at sale. Under the proposal, the wealthiest investors would pay on gains every year, whether the assets were sold or not.
The Administration estimates the new tax would affect just 0.01% of households and “reduce economic disparities among Americans and raise needed revenue.” But critics have pointed to the difficulty of calculating the market value of unsold assets and questioned the constitutionality of such a wealth tax. “In our view, it is highly unlikely the Billionaire Tax would become law,” Drossman says.
In the above video, Bremmer shares his views on whether sanctions are having their intended effect and discusses the prospects for a possible diplomatic resolution. He and Hyzy also look at the economic impact of a refugee crisis that’s growing by the day and explore the prospects for the European and Russian economies moving forward. Then Hyzy discusses the potential impacts of the conflict on global financial markets, as well as what positive signs investors could be watching for from here, with Michael Hartnett, Chief Investment Strategist, BofA Global Research.
“The ongoing crisis in Ukraine has accelerated certain trends — supply chain disruptions, repricing in the energy and broader commodity markets, and even how the Federal Reserve adjusts its approach to tamping down inflation,” says Hyzy. “It has also accelerated our view that inflation could be with us for some time.” With so much uncertainty in the markets, Hyzy emphasizes that diversification is increasingly important. “I would encourage you to review your asset allocation regularly and rebalance as necessary, keeping your risk tolerance, goals and timelines, as well as your liquidity needs, in mind,” he says.
For more insights on the Russia-Ukraine conflict from the Chief Investment Office, read the March 14 Capital Market Outlook. Catch up with Hyzy’s previous conversation with Ian Bremmer in the March 9 “Market Briefs” post on this page.
What’s behind the Fed’s interest rate hike?
AS WIDELY EXPECTED, THE FEDERAL RESERVE (Fed) on Wednesday raised its federal funds rate by .25%, the first such increase since 2018,1 in an effort to help control inflation that’s been rising at its highest levels in decades. Yet that process is complicated by a variety of forces — ranging from the Russia-Ukraine conflict to ongoing supply chain disruptions stemming from the pandemic — that could stall the economy. “The Fed understands that the bigger job at hand is to bring down inflation but still keep job growth humming,” says Chris Hyzy, Chief Investment Officer for Merrill and Bank of America Private Bank.
Higher rates are part of an overall process of monetary tightening, with the Fed pulling back from an extraordinary period when it kept interest rates near zero and pushed trillions of dollars into the economy through bond purchases, all aimed at keeping the economy moving through the global pandemic. With consumers facing rapidly escalating prices for everything from groceries to a tank of gas to appliances, and employers paying higher wages for workers, the higher rates ideally would begin to cool down inflation. (For more on inflation, your finances and steps to consider, listen to the recent Merrill podcast, “Inflation: How high, for how long?”)
Several more rate increases are expected throughout the year, as is a continuation of the Fed’s policy of transparency, telegraphing future increases in advance to help minimize market volatility, Hyzy says. Though the Russia-Ukraine war may complicate the Fed’s efforts to tame inflation in the short term, Hyzy believes the underlying fundamentals of the U.S. economy remain strong. For equity investors, the ongoing uncertainties suggest a time to emphasize quality — large, U.S. companies with strong balance sheets. Investors should focus on diversifying their portfolios both within and across asset classes, Hyzy adds.
Market Volatility and the Russia-Ukraine Conflict
“THE RUSSIA-UKRAINE CONFLICT is having an impact on us all,” says Andy Sieg, president of Merrill Wealth Management, as he introduces our latest webcast. “On a human level, we’re watching with great empathy. Closer to home, we share concerns about the impact this crisis is having on oil prices, inflation, the economy and markets.”
For insights on how the conflict could affect the world order and global economy — and how the crisis might be resolved — Chris Hyzy, Chief Investment Officer for Merrill and Bank of America Private Bank, turns to leading geopolitical expert Ian Bremmer, president of the Eurasia Group and GZERO Media and best-selling author of “Us vs. Them: The Failure of Globalism.”
Then BofA Global Research’s Savita Subramanian, head of U.S. Equity & Quantitative Strategy and ESG Research, and Ethan Harris, head of Global Economics, join Hyzy to share insights on the sectors most impacted by the conflict and how investors can respond.
Watch this timely webcast now, and then read “Time to Remain Calm and Balanced” from the Chief Investment Office.
Ukraine invasion: Should investors retreat to the sidelines?
WHILE FIRST AND FOREMOST A HUMANITARIAN CRISIS, Russia’s invasion of Ukraine adds another major disruption to investment markets already buffeted by inflation, potential Federal Reserve (Fed) interest rate hikes and persistent pandemic concerns. “The terrible situation in Ukraine is likely to keep many investors on the sidelines until there is some clarity on the immediate future,” says Chris Hyzy, Chief Investment Officer, Merrill and Bank of America Private Bank. But a better approach may be staying invested and focused on your long-term goals, he adds.
“The S&P 500 has fallen into correction territory, with a loss of over 10% year-to-date, and the Nasdaq 100 Index reached bear market territory,” Hyzy says. However, markets rallied somewhat in the immediate aftermath of Thursday’s invasion. Such severe disruptions do not signal the end of the current economic growth cycle, he believes. “Corporate balance sheets and individual savings remain healthy, and as the pandemic subsides, another major wave of innovations is just beginning.”
A new Chief Investment Office Investment Insights report, “Uncertainty at Its Highest Level, but the Repricing of Risk Is in Its Final Stages,” offers insights on how investors can manage through short-term volatility and what it may take to help calm the markets.
How volatile for how long?
Further volatility is likely in the weeks to come — much depends on the fluid and hard-to-predict situation in Ukraine. The first big step on the path to steadier market conditions in 2022 will come when the military crisis, however it unfolds, stops escalating, Hyzy notes. “We also need to see a full reopening of the U.S. and European economies as pandemic restrictions ease,” he adds. This could spur other key improvements, such as stabilization of oil prices.
Another key to calming the markets is how the Fed addresses rising inflation. Will it maintain a “diligent but measured” approach to raising interest rates and tightening the money supply without choking off the recovery? “This may seem like a lot to ask,” Hyzy says. “But these catalysts can work together, creating a chain reaction.” If that happens, markets could “grind higher” for the rest of the year.
What should investors consider now?
As events unfold, “investors should focus on diversifying their portfolios across and within asset classes,” Hyzy suggests. When rebalancing their portfolios, they may find opportunities to add stocks of well-established, profitable companies with solid balance sheets and attractive valuations.
Promising sectors may include energy, materials and financials, as well as large, well-established technology and industrial companies with substantial free cash flow. “More defensive sectors, such as healthcare, are likely to provide some growth and stability,” Hyzy notes. “We also believe areas such as travel, leisure and entertainment are attractive, given our view of a full reopening of the economy in the coming weeks and months.”
Finally, in periods of market uncertainty, it’s always a good idea to check in with your financial advisor. Schedule some time to talk about how these insights might align with your individual time lines, risk tolerance and liquidity needs, and discuss any concerns you might have about ongoing volatility, Hyzy adds.
For latest insights on this evolving situation, tune in to the CIO Market Update Audiocast Series.
Russia invades Ukraine: What investors need to know
RUSSIA’S SWEEPING ATTACK ON UKRAINE this week confirmed many observers’ fears over the escalating crisis and left the world wondering what will happen next. Political and diplomatic circles regrouped, and markets reacted to the heightened uncertainty. On the first day of the attack, oil prices spiked to over $100 per barrel1 and U.S. and global stock markets dropped.2
For those watching from afar, the economic news drives home how quickly global events can hit home in today’s world. Amid deep concern for those directly engulfed in the crisis, individual investors may wonder whether and what steps to take to protect their finances. At times like these, it’s especially important to keep the potential economic and market impacts in perspective, says Chris Hyzy, Chief Investment Officer for Merrill and Bank of America Private Bank.
Stay the course
“History tells us that geopolitical risk is rarely a reason to change your long-term asset allocation strategy,” Hyzy says. For one thing, despite rising oil prices, the U.S. economy is far less dependent on Russian energy than are other regions, particularly Europe. The United States is a major energy producer in its own right, and the current economy should be strong enough to endure temporary volatility, he notes.
Moreover, for all of its size and military power, Russia’s ability to affect non-energy financial markets is limited. A recent Investment Insights report from the CIO, “Russia/Ukraine Market Update,” notes the Russian economy ranks 11th in the world and its nominal GDP of $1.7 trillion in 2021 was slightly smaller than that of the New York metropolitan area. All of which suggests a strategy of sticking to one’s long-term investment goals rather than buying or selling out of fear.
At the same time, it’s important to prepare for short-term volatility whose severity may be difficult or impossible to predict as the conflict progresses. Now may be a good time to review your portfolio to ensure proper balance, with a broad mix of investments across and within different asset classes. “Diversification — which people often talk about, but don’t always practice — is what’s needed most right now,” Hyzy says.
Current conditions generally favor value stocks — good companies whose stock may be undervalued — and investors may want to look at sectors such as defense or energy. Those with short investment time horizons — say, two years or less — may want to consider owning a higher proportion of high-quality U.S. companies, compared to non-U.S. and reducing their allocation to riskier assets, he says.
Invest for the long term
For investors with a time horizon of five years or more, current volatility may offer a chance to strategically add investments at attractive prices. “We suggest that long-term investors buy into this weakness and continue to do that over time, with the idea that the current profit cycle is alive and well,” Hyzy says. “Five years from now, that cycle is likely to be even higher, with returns that benefit somebody who invests right now.”
For more insights, tune in to the CIO Market Update Audiocast Series and read the Investment Insights report “Uncertainty at Its Highest Level, but the Repricing of Risk Is in Its Final Stages.”
Start planning now to help lower your 2022 tax bill
IT’S TEMPTING TO PUT OFF thinking about next year’s tax returns until December — especially now that the Build Back Better (BBB) Act and its proposed tax changes are stalled in Congress. But there are still compelling reasons to consider your 2022 bill even as you focus on your 2021 returns. “In some ways, tax planning at the beginning of the year may be even more important than year-end planning,” says Mitchell Drossman, head of National Wealth Strategies in the Chief Investment Office (CIO) for Merrill and Bank of America Private Bank. A recent CIO Tax Alert, “Beginning of Year Tax Planning,” details some points to consider with your tax specialist. Here are just a few highlights.
Projecting your income
Instead of tabulating what you earned after the fact, “assessing your income at the start of the year could help you make better-informed decisions,” Drossman notes. Say, for example, you expect a sizable pay raise or increase in investment income this year. That added income could move you to a higher tax bracket, and if you own a small business, it could phase out your ability to claim a qualified business income deduction (QBI). “Running tax projection scenarios at the beginning of each tax year, with periodic updates, can help you avoid surprises and make timely adjustments,” says Drossman. You could, for example, move more of your assets into tax-exempt investments early in the year if you expect additional income that could move you into a higher tax bracket.
Anticipating potential tax changes
While the Build Back Better Act, containing an array of potential tax increases for high net worth individuals, stalled in Congress in December, the administration is likely to push for revised legislation for Congress to consider going forward. This legislation would likely retain a variety of potential tax changes while scaling down some spending provisions, Drossman notes. One possibility: A BBB measure ending “back door” conversions of after-tax funds in an IRA or 401(k) into a Roth IRA or Roth 401(k), where earnings can grow tax-free. “While potential tax changes remain uncertain, taxpayers planning such Roth conversions may want to consider doing so early on to take advantage of current rules,” Drossman says.
Funding your retirement plan
If you anticipate that investment markets will perform well this year, you might consider funding your 401(k) or IRA early in 2022 rather than incrementally throughout the year. “In a rising market environment, your contributions could have more months to potentially grow and compound tax deferred,” Drossman says. One possible exception: If your 401(k) includes an employer match, “you should consider the implications of fully funding your account early in the year,” he cautions. “In some instances, when your contributions stop, so will the company’s match.”
For more insights on these and other tax strategies, be sure to speak with your tax specialist, who can help you make decisions that are suitable for your personal situation.
A shifting landscape for bonds as interest rates rise
FOR BOND INVESTORS, RISING INTEREST RATES, global monetary policy and uncertainty over taxes create a shifting landscape for 2022, says Matthew Diczok, head of fixed income strategy, Chief Investment Office (CIO), Merrill and Bank of America Private Bank. A Fixed Income Strategy report from the CIO, “Global Monetary Policy and U.S. Fiscal Policy (Build Back Better),” offers insights on what could be ahead for fixed income and how you can manage through the uncertainty.
Fixed income in a rising-rate world
To counter inflation, the Federal Reserve (Fed) is expected to raise rates multiple times this year, starting in March, and the Bank of England has already done so twice. Yet central banks in Europe and Japan have been reluctant to follow suit as their economies continue to recover from the pandemic. When interest rates rise, bond yields follow. Given the interconnected nature of the global economy, investors should expect bond yields to climb, but only so high. “It may be difficult for 10-year U.S. Treasury rates to go substantially above 3% without similar actions by other major central banks,” Diczok says.
Taxes and municipal bonds
Last year, “the expectation of higher taxes sparked record flows into municipal bond mutual funds and exchange traded funds,” since muni income is free from federal and, in many cases, state and local taxes, Diczok says. Yet the $3.5 trillion Build Back Better Act, which would have increased taxes for many affluent Americans, stalled in the U.S. Senate last December. “A scaled-down version will likely be introduced this year, but passage remains uncertain.”
What you can consider doing
Based on these and other developments, Diczok and the CIO provide the following insights for bond investors:
- Don’t count munis out. With the tax picture in flux, municipal bonds in 2022 are unlikely to match last year’s torrid pace. Still, state and local tax revenues and pension fund levels have risen, and a separate piece of legislation, the Infrastructure Investment and Jobs Act, provided more than $1 trillion for municipal projects. “We believe municipal bonds will continue to provide value for tax-sensitive investors,” Diczok says.
- Focus on the overall yield of your bond portfolio. Bond prices tend to fall as interest rates rise, but “investors with the ability and willingness to hold during periods of price volatility can be relatively sanguine about market price moves related solely to interest rates and not actual credit issues,” Diczok notes. “With the Fed expected to raise rates several times in 2022, investors should focus on the overall yield offered by a portfolio,” he adds.
- Corporate bonds are worth a look. Compared with Treasurys, corporate bonds typically offer higher interest in exchange for higher risk, he adds. “Given the Fed’s commitment to markets and improving fundamentals, corporate bonds should provide modest positive excess return over the medium term,” Diczok believes.
- Treasurys provide diversification. Whatever the economic conditions, “bonds are essential in providing portfolio diversification, income and stability,” Diczok says. “We recommend maintaining some Treasurys for liquidity and principal preservation.” Above all, considering the complexities of the bond market and always-evolving economic conditions, be sure to speak with your advisor before making any decisions, he suggests.
Russia, Ukraine and the Markets: What to Expect
BEYOND THE GEOPOLITICAL AND HUMAN IMPLICATIONS, a Russian invasion of Ukraine could potentially rattle the global economy and markets at a delicate time. For one thing, “An invasion would likely add to inflation pressures in Europe, the U.S. and globally,” says Chris Hyzy, Chief Investment Officer for Merrill and Bank of America Private Bank. Though the situation remains unpredictable, a new Investment Insights report from the Chief Investment Office, “Russia/Ukraine Market Update,” details potential economic and market impacts, should worsening tensions lead to military conflict.
Russia and the global economy
While Russia has great geopolitical influence, “its overall economy is not large enough to significantly affect the direction of global growth, and U.S. corporate exposure to Russia is relatively minimal,” notes Hyzy. However, the country is a heavyweight in the global energy markets. Russia accounts for more than 10% of world oil production and exports a hefty 43% of what it produces. Europe, in particular, depends on Russian oil exports, leaving the region vulnerable should a conflict arise. “Higher energy prices act as a drain on global liquidity,” Hyzy says.
What can investors consider doing?
While investors should avoid taking sudden actions out of fear and uncertainty, “Now is a good time to review your exposure to certain sectors that could experience some volatility,” Hyzy suggests. Areas at risk include Russian and Ukrainian risk assets, European countries and European industries that are heavily dependent on Russian energy, as well as energy- and food-vulnerable emerging markets economies.
“Investors may also want to consider strategic exposure to defense stocks and commodities,” Hyzy says. But keep in mind that while commodities such as oil and natural gas could potentially benefit, “an increase in supply from the Organization of the Petroleum Exporting Countries (OPEC) or U.S. Strategic Petroleum Reserves could make a spike short-lived.” Other areas to consider include natural gas alternatives such as coal and nuclear energy, as well as fertilizer and food producers. “The situation also supports our tactical preference for U.S. versus international equities within a diversified portfolio,” Hyzy adds.
What’s driving the latest market volatility?
MARKETS DROPPED STEEPLY ON MONDAY amid fears over Federal Reserve (the Fed) policy changes, inflation, tensions with Russia over Ukraine and other concerns. The S&P 500’s 800-point slide1 into what The Wall Street Journal termed “correction territory”2 represents a new chapter in a year already marked by unsettling market swings. “The list of market risks has certainly grown in the last month, and they’re all converging,” says Chris Hyzy, Chief Investment Officer for Merrill and Bank of America Private Bank.
As unsettling as such events are for investors, Hyzy believes the current volatility reflects a natural reaction to fundamental changes rather than the onset of long-term decline. By the end of the day on Monday, the S&P had recovered some of its ground.3 “There is no recession in sight,” Hyzy says. In a new Investment Insights report from the Chief Investment Office, “The Meerkats and the Buffalo Market,” he details reasons for the current volatility and why he expects markets nevertheless to rise throughout the course of the year.
A convergence of concerns
In the face of stubborn and rising inflation, the Fed is tightening its monetary policies, which pumped trillions of dollars into the economy through the depths of the pandemic, and it is likely to raise interest rates several times this year. While rate increases are widely anticipated, “There are fears that the Fed may actually start with a 50-basis-point increase, which they’ve never done at the start of a tightening cycle,” Hyzy says.
Tensions between Russia and the West over the Ukraine border add geopolitical uncertainties. Closer to home, markets historically weaken approaching mid-term elections, Hyzy adds. On the positive side, they tend to rebound once elections are over.
Adding to investor concerns is the stark contrast between January 2022 and an unusually buoyant 2021. Monday’s correction comes on the heels of a year without a single correction of that magnitude. “In fact, we had only one 5% pull-back, which is extraordinarily rare,” he says.
Reasons for optimism
While 2022 is unlikely to match 2021 for market optimism, underlying economic factors remain positive, Hyzy says. Fed tightening was bound to cause short-term volatility, but “higher interest rates have historically not been a drag on equity returns,” he adds. “Bloomberg figures show that the 12 rate-hiking cycles since the 1950s on average have produced a 9% gain annually, with 11 out of the 12 including a positive return.”4
Meanwhile, consumer demand, a key driver of the economy, is likely to remain strong over the next two years, particularly for services that were curtailed during the pandemic, Hyzy adds. Yet due to the economic and geopolitical uncertainties and the likelihood of ongoing volatility through 2022, investors should focus on high-quality companies with records of stability and profits, he adds, and make sure to stay diversified as they invest towards long-term goals.
What do the latest inflation numbers mean for investors?
INFLATION, ALREADY RISING AT THE FASTEST RATE in decades, climbed again in December. The Consumer Price Index (CPI), which measures the cost of goods and services, reported an increase of 7%, year over year, up from 6.8% in November. On a month over month basis, prices rose more slowly in December: the rate declined, measuring 0.5%, down from 0.8% in November and 0.9% in October. Still, the 7% year over year number reflects the highest rate of increase since 1982.1 Not surprisingly, inflation is cited among the top concerns of Americans in various polls.
Here, Chris Hyzy, Chief Investment Officer for Merrill and Bank of America Private Bank, offers insights on what inflation may mean for investors, the markets and the economy.
Q: Why are prices rising so quickly, and how long could higher inflation last?
A: As we moved from pandemic lockdowns to reopening and recovery, consumers unleashed a wave of pent-up demand that helped the economy grow at three times its normal rate during the first half of 2021. That, combined with supply shortages, has driven prices sharply higher. In addition, above-average money growth is keeping inflation elevated even if some supply-chain issues fade. This is important to watch in 2022.
It’s also important to note that some inflation is good for the economy. Home prices have rebounded in areas where they’ve lagged, and wages and corporate earnings are up. In our view, inflation won’t continue at 6%-plus for the long term. We do, however, believe that inflation is likely to run well above the Federal Reserve’s usual 2% target — perhaps at around 3 to 4% — for an extended time.
Q: How might the Fed act to curb inflation?
A: In his renomination confirmation hearing before the Senate on January 11, Federal Reserve (Fed) chairman Jerome Powell reiterated the Fed’s intention to speed up the tapering of its bond-buying stimulus program to help keep prices from climbing higher.2 The accelerated pace would end the program in March, two months earlier than previously planned, setting up the possibility of three to four interest rate hikes this year. Furthermore, in a surprise coming out of its December meeting, the Fed also pivoted to discuss the potential for balance sheet contraction, or a reduction in the amount of assets the Fed holds, in 2022.3 In pivoting to higher rates and balance sheet contraction, the Fed will have to thread the needle, raising rates just enough to control prices, without moving too quickly and stalling economic growth. Markets will be watching very closely for a balanced approach by the Fed, as well as very transparent communication.
Q: What can investors consider doing?
A: From a sector perspective, industries such as materials and energy, which are able to pass along higher prices to their customers, may present opportunities for stock investors. Now is also the time for equity investors to focus on higher-quality balance sheets and consider adding dividend growth to their portfolios.
Though we continue to favor equities over fixed income, it may also be a good idea for investors to review their asset allocation and rebalance more frequently, always keeping their goals, timelines and liquidity needs in mind. Though we’re not there yet, rising bond yields could soon present opportunities for people in retirement and others looking for bond income, which has been hard to find during years of historically low rates.
For more insights on the markets and inflation, read “The Tightening Transition.” For ideas to help minimize the impact of inflation on your retirement savings, explore “Inflation – One of Retirement’s Biggest Risks – Is Back.”
Tax moves to consider now, while the Senate debates future changes
THE BUILD BACK BETTER ACT AND ITS TAX PROVISIONS are now with the Senate, where it’s likely that changes will be made before the bill comes to a final vote. In the meantime, taxpayers must begin thinking about their 2021 taxes. The following two resources, which reflect current regulations, can help as you begin having conversations with your tax advisor about your 2021 return.
Bank of America’s “2021 year-end tax planning” guide lays out potential year-end tax moves that could help to minimize your tax bill. Say, for example, you’re planning to sell a depreciated investment and use the loss to help offset capital gains taxes. The timing of that sale could make a difference, depending on your individual circumstances. Your tax advisor can help you make the appropriate decision for you.
As you prepare for 2022, remember, too, that annual federal tax limits change each year, potentially affecting your retirement and estate-planning decisions, as well as your tax strategies. For example, contribution limits for 401(k)’s and other qualified retirement plans, as well as the annual gift tax exclusion and the standard deduction all increase for 2022. For a full rundown of changes, see Bank of America’s “Annual federal limits relating to tax and financial planning 2022.”
Check back regularly for updates on potential tax changes, and be sure to speak with your tax advisor about your personal situation before making any decisions.
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You have choices about what to do with your 401(k) or other type of plan-sponsored accounts. Depending on your financial circumstances, needs and goals, you may choose to roll over to an IRA or convert to a Roth IRA, roll over a 401(k) from a prior employer to a 401(k) at your new employer, take a distribution, or leave the account where it is. Each choice may off er different investments and services, fees and expenses, withdrawal options, required minimum distributions, tax treatment (particularly with reference to employer stock), and provide different protection from creditors and legal judgments. These are complex choices and should be considered with care.
Diversification does not ensure a profit or protect against loss in declining markets.