How to communicate amid ongoing inflation and volatile markets

next issue no. 9: Investment corner

The market environment has been highly volatile and deeply negative through 2022. The particulars of the risk-off environment are also quite rare. In 2022, stocks and bonds are falling in tandem, breaking historical patterns. This is because the driver of negative returns is common to both — higher than expected inflation, exacerbated by the war in Ukraine, and concerns that central banks will raise rates aggressively to combat that high inflation and push the economy into a recession. All the major asset classes will struggle in that environment, especially after several years of high returns that saw valuations become relatively stretched.

Just as we discourage investors from market timing in general, we also caution that it’s extremely difficult to predict the bottom of a bear market with a high degree of precision. Attempts to define a projected or hoped-for inflection point to guide specific investment decisions are likely to produce disappointing results. We would continue to recommend consistent contributions to retirement savings that help to dollar cost average into accounts.

The ongoing market turmoil may be contributing to sharp declines in consumer sentiment surveys. Consumer confidence is registering about as low as it has ever been — lower now than during the onset of Covid when the economy was shut down. Fortunately, this is not translating into consumer behavior.

Consumers though are saying one thing and doing another. Despite their gloomy professed outlooks, U.S. consumers are exhibiting considerable strength. Rising asset prices (homes values as well as financial assets) and unusually high job security have combined to make consumers more resilient than we might expect to high inflation. Many households accumulated considerable excess savings during the pandemic, and while those balances have started to fall, they, along with rising wages and pent-up demand, are powering ongoing spending growth.

Inflation, which is currently running at a level most Americans have not experienced in their adult lifetimes, is undoubtedly driving negative consumer sentiment. Despite an aggressive series of interest rate hikes from the Fed, the rate of price increases has yet to subside. In fact, inflation has become broader based in 2022 compared with 2021. Energy and food inflation has risen primarily because of the war in Ukraine, but core service prices like rents are also climbing and could contribute to inflation’s ongoing persistence. The sharp rise in gas prices has only partially reversed, and given its visibility it has probably been the biggest contributor to negative investor psychology. Beyond engineering a recession, something they’d like to avoid, there is very little that policymakers can do in the near term about commodity prices or supply chain issues.

The labor market is very strong at the moment — job openings greatly exceed unemployed workers — which is putting upward pressure on wages. Wage inflation is concerning to investors as it can be hard to dampen without economically damaging policy changes. Higher wage costs can induce companies to raise prices on the goods or services they sell, which may lead workers feeling the pinch of inflation to demand even higher wages. This wage-price spiral eventually forces central banks to raise rates enough to slow the economy back down, add some slack back into the labor market and allow prices to climb in a more orderly manner.

So despite the risks of pushing the economy into a recession, the reasons for the Fed’s rate hikes are clear: Job creation and consumer spending have stayed strong, but inflation is running hot, eroding the purchasing power of incomes. The Fed wants to loosen the labor market but not break it as it tightens policy. Job security is important to keep the economy running even as job openings come down. The Fed clearly sees more risk coming from higher inflation than it does from a potential recession. And that’s a stance that makes sense to us.

What can we say to participants?

Still, while none of us can control these events, it’s important to focus on what we can control – and that’s the strategies we put in place to manage the conditions we’re handed. History tells us that from an investment standpoint designing, regularly contributing to and sticking to a good long-term asset strategy is the best way to achieve a long-term financial goal, retirement first and foremost.

Our Global Investment Committee expects inflation to moderate over the next 18 months. And our GIC also believes that even a mild recession should still create an environment where financial markets offer value, assuming you know where to look.

It must also be said that so far, evidence from our colleagues at TIAA suggests that we are not seeing reduced contribution rates. Hardship withdrawals have also remained flat, which is an optimistic sign. What we are seeing is tremendous engagement in people seeking information about what do now. Plan participants are desperate for information as to what they should do through times of high inflation and volatility. People want reminders to focus on the long term and to not panic. While market-moving events are uncomfortable, they often provide valuable investment opportunities — especially for people with a long-term outlook.

The value of remaining fully invested through periods of higher volatility is also paramount.

Historical evidence shows that when markets decline they tend to recover relatively quickly. And while the 2022 market decline is more severe than the majority of equity downturns, the recovery period historically has still been less than a year. In the 88 market declines measured, 82 saw recoveries in less than a year.

So the question for investors is focused on whether they have enough exposure to investments that perform better when inflation is 3% or 4% instead of 1% or 2%, as had been the case from the 1990s through the 2010s. Many real assets can help mitigate inflation, and in some cases are still poised to produce positive real returns. From rent escalators found in commercial real estate to CPI-based infrastructure projects to farmland assets bolstered by rising crop and land values, we see a number of ways to participate in elevated inflation levels or provide a cushion against them.

We do believe that investors should be considering rebalancing their portfolios during such periods. Participants need to make sure that their asset allocation remains in sync with goals — objectives for retirement and income are not likely to have shifted greatly, but the allocation of assets to achieve those goals may well have due to shifting valuations. Investor’s tolerance for risk also needs to remain in focus.

Ultimately we recommend that plan participants stay the course, do not panic — focus on the things you can control — cash flow, tracking for goals, don’t focus on day to day volatility. Making sure that a participant is saving enough day-to-day and invested correctly based on their goals remains the best advice. The dollar cost averaging inherent in a constant savings program like a 401(k) is of great benefit at a time when we see valuations across asset classes at attractive levels.

We also see recommendations in educating and reminding participants of the differences between the accumulation phase while working and the income phase in retirement. We would also continue to talk to the benefits of guaranteed lifetime income being built into a plan, as a blend of fixed and variable annuities can work to offset some inflationary risk and cement accumulated savings into a constant income stream. Our fuller article on the implementation and benefits of guaranteed lifetime income elements within a retirement plan can be found here. We see the security of a consistent paycheck as being a strong driver of lifetime guaranteed income elements, and could help women further into retirement after other potential options are exhausted.