Author: Tom Martin, CFA, Senior Portfolio Manager – GLOBALT Investments.
What’s fun about that? After reaching a new high on January 3rd, the S&P 500 declined relentlessly through January 27th by -9.7%. The NASDAQ Composite, just shy of its November high, declined by -15.6% over the same time period. The yield on the 10-year U.S. treasury rose from 1.5% to 1.8% from December 31st, and the Bloomberg U.S. Government/Credit index declined -2.4%. Things were a bit more jolly when the dips were shallower and didn’t last so long. The calls have started coming in. What’s going on? What should I be doing? Is this the big correction? What is GLOBALT thinking and doing? So about that…
Investor preferences have changed it seems. Market strategists had been talking about it, that 2022 was likely to be a volatile year, what with high valuations (of which some air would need to come out at some point), COVID, mid-term elections, persistent inflation, and a waking-from-slumber Fed. But it was thought that that would come…well…later. After a few months. And more like a sawtooth going sideways at first, not a waterfall starting day one. That’s not what we have been getting though. The markets are showing that there is currently a preference for value over growth and less of a preference (to state it diplomatically) for stocks and bonds. Investor sentiment has gone from bullish to bearish with amazing-to-watch speed, yet in the face of continuing inflows into global equities.
Inflation and the Fed are driving the fear bus. Sorry to bring up the obvious. This, however, is where GLOBALT has a bit of a departure with what appears to be baked and baking in of late. We went from, earlier last year, “inflation is transient,” like some scruffy undesirable passing through town, to “inflation is persistent,” like your n’er do well friend from high school who has taken up residence in the basement, eating up all your snacks and using all the hot water, and will need significant, unpleasant effort to dislodge and send on his way, so we can all get back to our usual life. So pressure is brought to bear on your reluctant uncle, the Fed, to do something about the situation. First they limit the snacks, then they say they are taking away all the snacks, then they say they are going to start charging increasing amounts of rent, then they are going to start throwing his clothes out onto the sidewalk. The family members cheer loudly. Maybe the unwanted guest will get the message before uncle Fed has pulled out all the stops.
Getting back to the real world, the markets have discounted four plus rate hikes in 2022 whereas last year there were expectations of none. This one change in the cost of money is what you might call a blunt instrument. Despite that, people say this will cool inflation but not slow the economy too much, nobody knows for sure, and it will take many months before the effects work their way through. That is the longer-term effect to watch as it develops. The markets, however, don’t want to hang around to find out. The markets say, “if discount rates go up, financial assets are worth less, so I am reducing exposure,” and the longer the duration asset and the more excessive the valuation, the less exposure they want. And this they can do, and have done, now, no waiting.
GLOBALT’s point of departure. Our view is that there are signs that inflation is coming off the boil already, and that it is reasonable to think that it might decline, for several reasons, to a less hair-on-fire number by the end of this year. The fiscal stimulus impulse in 2022 is a fairly large negative, employment participation appears to have room to rise and demand growth has scope to slow. It is possible that as we get to March and April and May that some of these things gain some visibility to the point where the Fed moves slower and adjusts rate path expectations downward, and the handwaving, foam finger pointing crowd on the upper deck of the bus quiets down a bit. It’s too early to tell, but long-term rates could be telling us that if short term rates are right, then the economy is at risk of sub-par growth in the longer term. In short, we do not believe this is the start of the Big Correction.
Stomaching the volatility—The environment we see as more likely in the mid to latter part of this year would favor a reversal of the preferences we have experienced thus far in January. Of course, we don’t know for sure if we will be proven out, or exactly how long it will take to get a better indication. In the meantime, the market moves have been big enough and fast enough, and the prospects of a reversal are high enough, that we believe the weight of the evidence indicates standing our ground. We believe stomaching the volatility is the best course of action currently. Back at the end of last year, this is what a number of professional investors were suggesting would need to be done this year. It is easy to say you’ll do it before it happens, but hard to do it when you are in the midst of it. This is not to say that we are complacent or not on high alert. We are. We are measured and prudent, and our number one priority is the effective long-term management of our clients’ wealth.
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