Inflation Still Impacting the Market - March Allocation

Welcome to March!  We had a down month across the board with a rocky final trading day.  However, we are still positive for the year, and months where we are down 1-3% are not uncommon and are just a snapshot in time.  We could very easily have a strong day tomorrow, so I strive to understand the larger picture beyond daily, weekly, or even monthly movements. 

The driving force for this month’s returns and today’s activity has been a multi-month and, dare I say it, a multi-year problem, inflation.  Our inflation numbers are coming in higher than expected and they are coupled with strong job numbers.  The Federal Reserve has an edict to keep inflation low and while also working to maintain full employment.  For those of you familiar with the IS-LM-FE model, a strong job market means there is still some slack in the economy which can allow us to raise interest rates a bit more to bring down inflation.  

This action is what the market saw today.  The market now thinks another 0.25% increase in the Federal Reserve interest rate will be added this year, for a total of 3 or 0.75% total, and any expect rate cuts have now been completely removed.  The result, they hope, is more savings in bonds, less spending using credit, and a slower economy resulting in lower inflation while at the same time not hurting full employment.  We will see how this plays out.  This also means bonds become more attractive than stocks; hence a lower performance this month.

With a strong job market, we are seeing a strong small cap market as well.  It is the leader for the year at over 9%, but I would be foolish to try and chase the returns and “jump on the bandwagon.”  Higher interest rates for a longer period will impact smaller companies, and this factor has probably has not been priced in yet.  The rest of the year is still uncertain regarding our overall economy, and we are seeing weakness in tech sector jobs and the housing market. The small caps have always been a bit more susceptible sudden surprises, and at this point, my model is showing that inflection point is still too risky to be in the small caps. 

I am still 100% in the I Fund. 

This of course is not without risk too.  The European Central Bank is still trying to control inflation in their area of the world, which represents a sizable portion of the I Fund.  They will attempt to control their inflation with raising interest rates without regard for full employment, so I will be monitoring those actions as well, which could change my calculus for next month.  Keep investing!