Quarterly Commentary 1Q’22

The (Surprisingly) Strong Economy

Let’s start with positive news about economic strength as we recap the 1st Quarter of 2022. Overall, the US has continued to rebound out of 2020’s pandemic-driven recession with healthy economic activity. Job growth is robust, wages are rising, and consumers keep on spending.

Contrasted with the relatively sluggish Great Recession recovery, the current rebound has been short and sharp – and in many ways more “normal.”  When demand for goods and services increases as it’s doing now, we expect rising inflation to follow. That is indeed what we’re currently seeing, with the US consumer price index rising at an 8.5% annual rate in March.

So now it’s the Federal Reserve’s job to help cool the hot economy and rein in inflation, but not so much that it causes a recession. In March, the Fed raised rates by 0.25% and indicated multiple hikes are likely to follow, kicking off a new cycle of rising interest rates. Just how much Fed action will be needed remains an open question.

 There are of course critical complicating factors. Pandemic-related dynamics continue to impact the supply chain, exacerbated by new Covid lockdowns in China.  The unprovoked war in Ukraine and the ensuing sanctions on Russia are intensifying shortages of energy, minerals, and food commodities, leading to heightened concerns about runaway inflation on the one hand and fears of global recession on the other. In addition to causing unimaginable human suffering, the war is adding uncertainty to the global economic outlook.

One of the biggest risks to the global economy is the threat of food insecurity in many parts of the world. Ukraine and Russia supply ~25% of the world’s wheat as well as other food staples and shortages loom as the war continues.  Global leaders have so far indicated possible actions like increasing agricultural production and pausing trade restrictions; however, more rapid and aggressive action may be necessary to avoid a food crisis. We’ll be monitoring this situation closely.

This combination of concerns around rising inflation and other risks weighed on markets during the quarter, and all the major stock and bond benchmarks declined.  The US-based S&P 500 returned -4.8%, MSCI All Country World Index -5.3%, and the Nasdaq composite index -9.0%. Growth-oriented technology, telecommunications, and consumer discretionary stocks were most negatively impacted, making this a challenging quarter for growth-focused investors like Figure 8.  With interest rates increasing, bonds also struggled. The Bloomberg Barclays Aggregate Bond Index delivered -5.9%.

 As we manage portfolios in this shifting environment, we’re focused on investing in stocks with strong sustainability-driven growth prospects and reasonable valuations. For accounts with a fixed income component, we’re taking advantage of increased yields to buy. Recent purchases include bond instruments financing electric buses in Indianapolis, school solarization in Oregon, mass transit in the Bay Area, land conservation in California and Washington, and an impact think tank in Utah.

A Time for Conviction

Energy markets have played an especially central role in markets year to date. Oil prices, already impacted by shortages, soared to $130/barrel after the war in Ukraine began. Traditional energy stocks rose as well, outperforming all other parts of the market. The conventional energy sector led the S&P 500, rising 38% during a quarter in which most areas of the market saw a retreat. 

Since higher oil prices impact the world’s economically vulnerable populations the most, there have humanitarian calls for more increasing supply via releasing national reserves or upping production. There have also been protests that producing more oil and gas now is exactly the opposite of what needs to happen given threats posed by climate change.  As Secretary General of the United Nations Antonio Guterres recently declared, “Investing in new fossil fuels infrastructure is moral and economic madness.”

We see oil’s recent leadership as a short-term aberration in the longer-term global transition away from fossil fuels. As seen in the chart, fossil fuel stocks have outperformed year-to-date, but severely underperformed over the past six years. We maintain our view that while there may be short-term profits from investing in oil and gas, investments in renewable energy technologies present significantly better longer-term prospects for investors.

The latest “WG3” report from the Intergovernmental Panel on Climate Change (IPCC)* provides further evidence that we must reduce our reliance on oil and gas starting now. To keep warming under 1.5C, IPCC’s scenarios show that global use of natural gas needs to fall 45% below 2019 levels by 2050, oil by 60%, and coal by 95%. The report also emphasizes some very good news: we already have the technologies, materials, and know-how to get started.  We can begin making major reductions in GHG emissions now. The question is, can we summon the collective will to do so?  The IPCC report says – and we agree – that we can and we must.

 *Find the full WG3 IPCC report at https://www.ipcc.ch/report/ar6/wg3/; for an excellent summary, visit https://www.carbonbrief.org/in-depth-qa-the-ipccs-sixth-assessment-on-how-to-tackle-climate-change. We encourage you to check out Chapter 5, where the IPCC gives guidance on the socio-cultural aspects of mitigating climate change: things individuals can do, like driving less and eating plant based foods to make the most measurable impact.