Market movements during the second quarter have been unpredictable and narrowly focused. The Fed’s fight against inflation still weighs on markets. The Fed has paused. For now. With long term inflation still expected to rise, this pause is just that. A pivot in central bank policy may only happen if the order of magnitude changes significantly, i.e. the size of employment numbers and wage growth, or if there is a market event. This is true for both the Fed and the RBA.
Beyond an emphasis on liquidity, we continue to think investors should focus on balance sheets and cash flow and avoid highly volatile and speculative assets.
Central banks are at an impasse, raising rates to fight inflation, while creating liquidity to ensure banking systems. Markets too, are at an impasse. Long-term rate expectations have fallen, but recessionary risks have increased.
Asset allocation has come back to the fore, as prudent investors focus on what can go wrong, rather than to attempt to forecast what might go right. Risk management is everything. Liquidity will be key to take advantage of opportunities that present themselves.
If there was one word to define 2022 it would be ‘policy’. With the inflation genie out of the bottle and the tectonic plates of the geopolitical sphere shifting, there has been a dial up of a new course of action by those empowered to do so. Emotive sellers make for good buying. Anticipating the irrational fear that economic weakness can instil has historically been the platform for long-term wealth creation.
Investors are deep in the inflation era. The Fed’s narrative is unambiguous. The Powell pain is coming and the question of a soft or hard landing is now ‘soft-ish’ or hard, that is, it is going to be harder than soft.
If a recession for 2023 is the base case, be prepared for a plethora of opportunities to surface. It is in these times that astute investors buy from the pessimists.
The era of easy money ebullience is over. While we are not at the point of despair investors are feeling the bear market blues. It is wise to remember that bear markets are normal and tend to be short-lived. The question of reaching the peak or trough is a perpetual one and no investor has ever picked either.
As the Russia/Ukraine conflict has highlighted, all financial markets are so interlinked, you do not know where the issue will be. Investors need to be wary. We however remain confident that central bankers, learning from the lessons of the past, will see us through. It is time to look at that past, the 1970s.
For the past few ViewPoints we have, some would say, been kicking and screaming about the persistence of inflation and the market’s apparent ignorance. We had labelled this ‘inflacency’, and while the problem seems to be gone in the short-term, it appears the dreaming in markets has not evaporated, it has just been pushed further into the future.
The pace of economic growth is diverging. Some emerging markets are tightening, Europe and the US are heading toward tapering, growth in Australia has all but faltered and China has its own set of problems.
Markets appear to have priced in a return to ‘normal’. With an unwavering commitment by central banks to not fight inflation. The environment is being called reflationary. Reflation has happened before.
While e-commerce penetration has quantum leaped the last few months we observe a potential regime change may be at hand. For the last few years across developed markets, growth stocks have outperformed value by a long way. This may be coming to an end.
It’s the definition of Black Swans that you don’t see them coming. Two have sailed into view: COVID-19 and an oil shock. In some ways they offset, in others they amplify. And it’s early days to have clarity on how big or how long-lasting their impact will be.
This time a year ago, the trade war was going to be quick and “easy to win.” Now it’s clear that it will be an ongoing series of, often escalating, skirmishes, punctuated by face saving “deals” and “phases”.
Seasoned investors talk of markets “climbing the wall of worry.” That is, far from potential problems pushing markets down, fear is leaving players under-invested and markets despite the uncertainty trend upwards. You could say that in 2019 the market has been vulnerable to relief rallies!