Wow, what a week!
We are certainly in a different market environment as the Federal Reserve begins raising interest rates both long and short. I’ve spoken to several clients who are asking why things seem to have gone south so fast.
First, the recent downturn in the equity and bond markets is happening simply because large market participants do not believe the Federal Reserve can orchestrate a soft economic landing. As I mentioned in my January letter, the Fed doesn’t have a great track record of being able to raise rates without running the U.S. economy into a ditch. As a result, investors are selling because they want to get ahead of a possible recession.
The Federal Reserve has two mandates: full employment and inflation below 2%
We’re at full employment and then some, but inflation is currently running at 8% per year, but what is going on under the surface?
- Large institutional investors believe it will be necessary to raise rates much more than the Federal Reserve is indicating. Federal Reserve Chair Jerome Powell has indicated they are not considering raising rates any more than .5% in June and July. There are some, including myself, that believe by the end of the summer, the economy will have slowed enough that it will not be necessary continue raising rates. In my opinion, the Fed didn’t start raising early enough, and I’m skeptical they’ll stop at the right time. We’ll see. Historically, they tend to overshoot and undershoot.
- Technology stocks, which led the rally last year have seen huge declines in value and are somewhat reminiscent of the “tech wreck” in 2000. The good news is that unlike 2000, there are many companies in the technology sector with strong fundamentals and are likely trading below where they should.
- The inflation we’re experiencing is happening for several reasons. First, the White House and Congress continued stimulating the economy long after it was necessary. Once we reached full employment, they should have stopped the stimulus.
Second, most professional investors (like me) believed the Federal Reserve should have started hiking rates last summer. Because of these two factors, we now have about $5 trillion more in the economy than we should.
- Then there are supply chain issues, which are only getting worse as China continues to quarantine large portions of their population, plus a worker shortage in the U.S. that is making it difficult to get goods from point A to point B.
- The investment community knows the Federal Reserve has used up most of their recession fighting ammo. If we go into a recession, because of the amount we’ve already borrowed as a nation, we will be limited as to how we respond.
- Lastly, in addition to being tragic, since Russia is the 2nd largest oil producer on the planet, the war in Ukraine and the sanctions on Russia have caused massive spikes in oil prices. Inflation in oil prices eventually works its way into every area of the economy and as a result can create very broad inflation.
How do you invest now?
Since the wind has come down and are sails are no longer getting us where we need to go, it’s time to row. What does that look like?
- First, don’t panic - If the recession does come, it’s likely it won’t be until 2023. Unfortunately, what we’re seeing in the markets is what investors think will happen 12 to 18 months from now, so expect higher volatility until then.
- Buy Non-Correlated assets - In times like this when it seems the market has a greater chance of going down than up, assets that don’t move up or down with the market can be quite helpful. This is what is meant by “non correlating”. We've already started added these types of asset to our models.
- Maintain a larger than normal cash position in your portfolio - This helps avoid selling securities to provide distributions. We currently have 2 years’ worth of cash in our models to help us ride this out.
- Be a little more tactical – This is the hard one. While I don’t want to try to time the market, I do use technical indicators to try make wiser buying and selling decisions. Currently, we are in a clear downtrend and until there is some sort of catalyst to change the trend, it will likely continue. However, hitting a technical bottom (a line on a chart most professional investors believe in) can be a catalyst. One thing is for sure, we’re closer to that point than we were in the Fall.
The opinions voiced in this material are for general information and are not intended to provide specific advisor or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All investing involves risk including loss of principal. No strategy assures success or protects against loss.