The war in Ukraine, inflation, and an increased likelihood of recession are frequently in the news and on investors’ minds. ATX Portfolio Advisors^® clients have certainly shared those concerns and have been asking a lot of questions as a result. I’m sure many of those topics are of interest to most of our clients and prospects so I thought it may be helpful to share some information and thoughts on those questions I'm hearing most often as of late.

How Exposed Am I to Russia?

One of the most frequent questions posed since Russia invaded Ukraine back in February has been how much exposure our investment models have to Russia. Our models are primarily invested in mutual funds and exchange traded funds (ETFs) from Dimensional Fund Advisors (DFA). DFA had previously reduced exposure to Russia after Vladimir Putin's takeover of the Crimea in 2014. After the invasion in February of this year, DFA took the additional step of removing Russia from their list of approved markets for investment. Their plan is to divest all Russian holdings from their portfolios as market conditions allow. You can read additional details in their March 1, 2022 blog article titled Navigating Geopolitical Events.

How High Will Inflation Go?

Inflation has been high on just about everyone's list of concerns as not only are we frequently hearing about it in the media but we are personally experiencing it at the grocery store, the gas pump, and just about everywhere else (but the stock and bond markets) it seems.

While I don't have a crystal ball to predict how high prices may go, there may be some indications that prices are likely peaking. One of those indications is the difference between the yields on inflation-protected bonds and plain old regular bonds of similar maturity. That difference is known as the "Breakeven Inflation" (BEI) and it is essentially the bond market's expectation of inflation.

The one-year BEI is illustrated below in Exhibit 1. You can see the spike in inflation expectations earlier this year as the consumer price index (CPI)rose. But the direction seems to have reversed recently since peaking at 6.3% in late March, the one-year BEI had fallen to 5.2% as of June 10. While no guarantees exist in the investing world, this indication shows the market is starting to price in inflation coming under control. You can read more about his in DFA's June 10, 2022 blog article Light at the End of the Inflation Tunnel?

Exhibit 1. Brighter Horizons

1-Year Breakeven Inflation Rate, January 1, 2021 - June 10, 2022

How Much More Will the Market Fall in a Recession?

As the Federal Reserve has started to raise interest rates and reduce the amount of bonds they hold from the quantitative easing (money printing) of the past decade plus, concerns of a recession have increased. This week, Goldman Sachs raised their 2 year forcast of the probability of a recession to 48%. Fed Chair Jerome Powell did little to ease those concerns he acknowledged "the possibility" of a recession resulting from their actions to stem inflation.

The recent stock market volitility is at least, in part, suggesting that investors anticipate a slowdown. But we likely won't know if we are in or were in a recession until well after it began. In fact, recessions are proclaimed by the National Bureau of Economic Research by reviewing a variety of indicators such as consumption and income data, employment rates, and gross domestic product growth. The proclamtion doesn't occur in real time.

Often, markets have began recovering by the time of the announcement. As shown in Exhibit 2, the stock market had already bottomed out prior to the announcement month in two-thirds of recessions since 1980. In 2020’s recession, for example, the market’s low point came in March, three months before the announcement in June 2020.

Exhibit 2. Fret Lag

Recession Announcements vs US Stock Market Lows

Business cycle peak and recession announcement dates sourced from the National Bureau of Economic Research. US market represented by the Fama/French Total US Market Research Index. Past performance is no guarantee of future results. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio.

It certainly doesn't mean we have seen the bottom of the bear market we are currently experiencing, but even the folks that will determine if there is a recession will have to wait for the data to tell them. Perhaps the market has already spoken, in any event, selling because of a possible recession is, at best, a guess. You can read more about this in DFA's June 17, 2022 blog article Are We Headed for a Recession?

If the market has you guessing about what your next steps should be, perhaps we should chat about your plan.