Friend or Foe

January 14, 2022 by Martin L. Yokosawa

I hope everyone enjoyed the holidays and stayed healthy through the current highly contagious COVID variation, Omicron. I’m by no means a health expert, but I do read a great deal about most everything. A few ideas that I have read indicate that the Omicron variant is not as deadly as previous variants, especially to those with COVID vaccinations, and that “nature’s vaccine” of herd immunity may reduce COVID news to a topic in history books. Let’s hope so.

During the fourth quarter of 2021, the S&P 500 Index gained 10.7%, the NASDAQ Index gained 8.3%, the Russell 2000 Growth Index was down 0.1%, and the iShares Barclays 7-10 yr. Treasury Bond ETF (IEF) was down 0.2%.^[1]

Due to the onset of the Omicron variant, the Federal Reserve (Fed), the U.S. central bank, kept their stimulus policies in place and are only now taking action to reign in persistent inflation. The Fed was our friend in taking quick and sweeping action to mitigate the immediate negative effects of closing down the economy due to the COVID outbreak.

To shore-up the economy, the Fed cut short-term interest rates to near zero and started buying bonds to lower long-term rates in 2020 as the coronavirus pandemic hit the U.S. economy. Their policies remained intact, and our central banks portfolio of bonds hit $8.8 trillion on the mantra that the inflation was transitory. Thinking that this size of stimulus being pumped into the economy would not create an inflation problem is ridiculous.

To give you an idea of the magnitude of a large number like a trillion, let me put it into perspective using time.

One million seconds is about 11 and a half days.

One billion seconds is about 32 years.

One trillion seconds is 32,000 years.

Now, during his congressional testimony on Tuesday, Federal Reserve Chairman Jerome Powell called high inflation a “severe threat” to a full economic recovery and said the central bank was preparing to raise interest rates because the economy no longer needed emergency support.

The Fed has indicated that there could be three interest rate hikes this year, and the first could come as soon as March. The ongoing COVID pandemic remains a confounding factor that could spur further inflation due to tight supply conditions and increased production costs or it could temper it due to a reduction in spending and hiring.

The Fed is in a catch-22 situation of dealing with inflation which may let the economy falter or not aggressively deal with inflation and let it get out of control. That would not be good as countries like Zimbabwe know too well.

So far, the stock market has only had a few knee-jerk reactions and remains near its high despite the obvious headwinds. Over time, the stock market is a discounting mechanism and reflects future earnings in today’s prices. As I wrote in my last quarterly review, I believe there will be a rotation out of the past market leaders and a general correction could develop.

Here’s how I see things today.

Positives:

1. The economy is doing well despite the drag from the Omicron variant

2. The Fed has recognized, albeit late, and pledged to tackle rising inflation

3. Data from South Africa and Europe indicates that the Omicron variant seems to peak quickly which means a track to normalization may come sooner than expected

4. Pent-up consumer demand exists

Negatives:

1. Inflation is persistent

2. Interest rates will be on the rise, but the magnitude and speed continue as an unknown

3. Supply chain disruptions continue, but should subside through the year

4. Labor shortages continue which increases the cost of goods

5. Geopolitical unrest is on the rise

I expect there will be pockets of opportunity for disciplined investors, but it won’t be an easy year. Especially since we will be facing the mid-term elections in the fall. It should be quite interesting.

To our existing clients, I extend my sincere thanks for your business. You have our continued commitment to your success. To prospective clients, I invite you to come and grow with us.

Very truly yours,

Martin L. Yokosawa

Torii^® Asset Management, Inc. Landolt Securities, Inc.

9S040 Stearman Drive, Naperville, IL. 60564

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[1] These returns are priced based and exclusive of dividend reinvestment.