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Economic and Market Environment

First Quarter 2022

THE FIRM'S OUTLOOK: SUMMARY AND CONCLUSION

The Economy

  • From depressed levels of 2020, real GDP experienced its highest growth in decades in 2021.
  • Growth should be slowing in 2022, from near 6% real GDP to around 4%, still well above average.
  • Inflation is currently the greatest economic concern. It is running at the highest levels since the early 1980s. Even if it turns out to be transitory, it is lasting longer than expected and represents a threat to the longevity of the economic recovery/expansion.
  • We believe the economy is in the process of transitioning back toward normal rates of growth. If inflation can be reduced and contained, it is possible for the economy to enjoy a lengthy recovery/expansion cycle.
  • A strong consumer, with high cash balances and more wealth from home equity and stock appreciation, undergirds the economy.
  • The Federal Reserve (Fed) has made a dramatic pivot on policy. Quantitative easing is being reduced sharply, and federal funds are projected to rise in 2022. Warning: Fed efforts to fight inflation have, in the past, led to recession.

Stocks and Bonds

  • Stock returns have been extraordinary. 2021 was the third straight year of above-average returns, and over the last five years stocks have compounded at near 18%.
  • Stock returns have been driven by low interest rates, strong earnings, dividends, and buybacks.
  • Concentration among a few large technology companies that have appreciated sharply has obscured more average returns from the majority of stocks.
  • Bond yields are reacting to the Fed pivot. Short term yields are rising, but surprisingly, longer yields have fallen. One would expect yields to be rising in line with Fed policy.
  • While bond yields can rise in line with Fed tightening, we believe the era of low interest rates is not over.
  • The financial markets are always subject to geopolitical developments. We predict that in future years, management of the U.S./China relationship will be among the more important global challenges. We believe high-quality, liquid investments are the best hedges against these threats.

THE ECONOMY: IN TRANSITION

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  • The table above represents Fed projections. These forecasts are unlikely to be realized precisely, but we assume they are directionally correct.
  • We believe the economy is in the process of transitioning to its normal level of performance. The successful completion of this process will largely depend on the course of inflation.

INFLATION: HERE TO STAY?

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TEAM PERSISTENT

  • Excess fiscal stimulus
  • Spreading price hikes beyond pandemic-affected areas
  • Wage price spiral
  • Tight labor market
Team Captain: Larry Summers
VS.

TEAM TRANSITORY

  • Normal aggregate demand
  • Supply side bottlenecks will fade
  • Covid influence lengthens bottleneck issues but does not make them permanent
  • Long-term inflation expectations contained
Team Captain: Paul Krugman

INFLATION: HERE TO STAY?

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  • Even though headline inflation has spiked, longer-term inflation expectations remain anchored.
  • Hopefully, this is a sign that inflation psychology has not changed.
  • Longer-term inflation expectations have remained remarkably consistent over the last twenty years.

MONETARY POLICY: THE FED'S BIG PIVOT

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  • Higher than expected and more persistent inflation has forced the Fed’s hand.
  • Fed policy is changing:
    • Reduce bond buying from $120 billion per month to $45 billion per month and complete by March.
    • Expect to implement three Fed Funds increases in 2022 to near 1%.
  • The Goal: Give priority to inflation control over full employment, which in reality has essentially been achieved.
  • Inflation: Aggregate demand should be reduced, although gradually, and interest rates should be rising.
  • Risk: In almost all previous periods when the Fed has tightened policy to fight inflation, recession has been the end result. This bears monitoring. Soft landings are difficult to achieve.

THE ECONOMY: SOLID FUNDAMENTALS

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  • The U.S. economy requires increasing demand to support growth.
  • The consumer is the most important element in aggregate demand:
    • Wages are rising, particularly at the low end of the income scale.
    • Home equity is at an all-time high. Some 60% of Americans own their home, thus wealth improvement is widespread.
    • Stocks are near all time-highs. Some 50% of Americans own stocks in one form or another.
    • Incremental wealth represents the potential for increased consumption. This is a good sign for the economy.

WHY STOCKS HAVE DONE SO WELL, AND SHOULD CONTINUE TO (PART 1)

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  • Investors, while grateful for high returns from stocks, wonder why they keep rising.
  • The opposite chart supplies the answer. Corporate profits as a percent of GDP have tripled over the last 30 years. This is remarkable.
  • If the corporate sector continues to garner a larger share of total wealth, should this not be attractive to investors?
  • How has the corporate sector accomplished this?
    • Margin expansion
    • Above-GDP revenue growth
    • Increased leverage
    • Increasing monopoly power
    • Buybacks and dividends
    • Tax relief
    • Globalization
  • All of the above have been factors in the strengthening of the corporate sector in our economy. The outlook remains positive.

WHY STOCKS HAVE DONE SO WELL, AND SHOULD CONTINUE TO (PART 2)

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  • Corporate earnings are almost always on an upward trajectory, although temporarily interrupted by recessions. As earnings increase, stocks rise in concert.
  • While stocks do not move upward perfectly with corporate profits, the trend is the same.
  • When the upward trend in corporate profits and stock prices diverge, price to earnings ratios are either increasing or decreasing.
  • The chart opposite indicates that stocks have been appreciating faster than profits recently, as valuations on stocks have benefited from low interest rates, among others.
  • The outlook for corporate profits remains strong. Increases in the 10% range are expected in 2022.

THE QUALITY FACTOR: IT REALLY HELPS IN DOWN MARKETS

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  • Quality is the north star of common stock investing at Crawford.
  • We believe it insures both upside participation and downside protection.
  • While the downside of markets has not been an issue as of late, it is the nature of stocks to deliver periods of upside and downside.
  • The above clearly illustrates how quality has added to returns during periods of weakness in stocks.

THE ECONOMY: KEEP YOUR EYE ON THE 10-YEAR TREASURY NOTE

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  • The yield on the benchmark 10-Year Treasury note may be the most important interest rate in the world.
  • What is it telling us about the economic state of the world right now?
    • Perhaps, it would like its yield to rise more but Federal Funds has it tethered.
    • Perhaps, because it yields 1.50%, we live a structurally different economy that is unlikely to return to its former state.
    • Perhaps, because it refuses to increase its yield means that inflation is in fact transitory.
    • Perhaps, because its yield has not increased implies that we should not worry about deficit spending, at least now.
    • Perhaps, it believes the economy will be returning to “normal” soon.

GOVERNMENT DEBT: A DIFFERENT WAY OF THINKING

  • U.S. government debt has been increasing steadily over time creating fears of dire consequences for the economy and markets.
  • The traditional method of gauging debt is as a percentage of GDP. The chart opposite illustrates the steady rise over time.
  • As a matter of perspective, government debt as a percentage of GDP can be viewed differently. One might consider:
    • Present value of GDP infinite period: $3.8 quadrillion
    • U.S. federal debt held by the public: $22 trillion
    • Debt as a percentage of infinite horizon GDP: 0.5%
  • Implication: a 0.5% increase in revenue as a share of GDP or reduction in spending as a share of GDP would be sufficient to pay off the entire debt.*

*Source: Jason Furman and Lawrence Summers; DISCUSSION DRAFT - A Reconsideration of Fiscal Policy in the Era of Low Interest Rates; November 30, 2020

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DISCLOSURE STATEMENT

Crawford Investment Counsel, Inc. (“Crawford”) is an independent registered investment advisor. More information about the advisor including its investment strategies, objectives and fees can be found in its Form ADV, Part 2 which is available upon request.

Past performance is not indicative of future results. All investments carry a certain degree of risk of loss, and there is no assurance that an investment will provide positive performance over any period of time. This material is distributed for informational purposes only. The statements contained herein reflect opinions, estimates and projections of Crawford as of the date hereof, and are subject to change without notice. Forecasts, estimates, and certain information contained in this commentary are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Any projections herein are provided by Crawford as an indicator of the direction Crawford’s professional staff believes the markets will move, but Crawford makes no representation such projections will come to pass. Crawford makes every effort to ensure the contents have been compiled or derived from sources believed reliable, and contain information and opinions that are accurate and complete; however, Crawford makes no representation or warranty, express or implied, in respect thereof; takes no responsibility for any errors that may be contained herein or omissions; and accepts no liability whatsoever for any loss arising from any use of or reliance on this report or its contents. Crawford reserves the right to modify its current investment strategies and techniques based on changing market dynamics or individual portfolio needs.

The opinions expressed herein are those of Crawford Investment Counsel and are subject to change without notice. This material is not financial advice or an offer to sell any product.

Forward-looking statements cannot be guaranteed. This document may contain certain information that constitutes “forward-looking statements” which can be identified by the use of forward-looking terminology such as “may,” “expect,” “will,” “hope,” “forecast,” “intend,” “target,” “believe,” and/or comparable terminology. No assurance, representation, or warranty is made by any person that any of Crawford’s assumptions, expectations, objectives, and/or goals will be achieved. Nothing contained in this document may be relied upon as a guarantee, promise, assurance, or representation as to the future. CRA-21-401