“Often the fear of the thing is more devastating than the actual thing.”
I don’t know who said that first but it likely was not me!”
Quick question – have you ever been sitting in “that lecture”? You know the one where despite your best efforts your eyes begin to droop and you find yourself taking those micro, or not-so micro naps?
Well, the goal of my monthly market updates is to write things in a way that people who are not as into the statistics and “nerdy analysis” can read and understand without falling into a deep sleep. So here is the deal as I see it and folks can feel free to disagree!
Inflation has, in comparison to recent history, skyrocketed basically due to the age-old factor of too much money chasing too few goods. That is economics 101. Lots of money from the government while folks stayed home with more time to think about shopping with their new money and low interest rates. Meanwhile, since folks were staying home, supplies did not get produced and were/are not being delivered. It has been a perfect storm for inflation.
Now, the government and the Federal Open Market Committee (FOMC) wants to put on the brakes all at the same time by both tapering their bond purchases and raising rates at the same time as supply chain constraints still exist. Add to that the potential world conflict off the coast of Taiwan and on the boarder of Ukraine, the former potentially impacting the supply chain and the later increasing energy prices. (both adding to inflationary pressures)
All of this results in two things the market tends to hate; Fear and uncertainty, neither of which are known for inducing logical, rational decision making.
In this update we will do our best to address:
- The Volatility Outlook
- Interest Rates & Inflation
- Profit Positioning for 2022
The Volatility Outlook:
Let’s get right to the point – volatility is likely to stick around for a while. Keep in mind volatility goes both ways, both up and down. As I see it, the FOMC will raise rates and taper bond purchase at the same time. The market tends to trade in advance of these things, so I believe we may have already seen the worst of the correction due to these forces and could even rally as the events actually happen. What remains to be seen is what continues to transpire overseas. I anticipate the FOMC will go too far too fast, and we will start to see the word “recession” talked about on the news network news shows as early as the end of this quarter.
But wait, there is more!
- We are already seeing inventories rise because, as any manufacturing manager who values their job knows, when supplies are tight you order from more than one supplier. What often happens is that you end up with too much inventory – this could put downward pressure on prices because carrying inventory is expensive.
- Businesses that are more forward-looking have already secured the right number of supplies for the right time. These businesses will be rewarded while others will search for supplies. Others are service businesses that do not have any need for inventory. Certain of those service businesses are making money, are innovative, and do not have a lot of debt that will get more expensive as rates rise. This group should see their value rise as the panicked indiscriminate selling begins to taper off.
- We believe that the FOMC will continue its tradition of being unable to orchestrate a “soft landing” and will not raise rates as much as the market has anticipated given all the other forces at work.
I know – many of you are yelling at me to take a stand one way or another right now. I am never one to disappoint! I remain bullish but not on the overall market. I believe the winners and losers will slowly become very separated. As this happens, it could lead to increased market volatility as those who are blindly investing in the broader market pass their pain threshold and exit the market. We remain excited about being in the early stage of a major innovation cycle larger than any we have seen before but the ride could be quite difficult for many to stomach.
Interest Rates & Inflation:
This one may seem obvious, and we have already seen residential mortgage rates jump higher causing many would-be home buyers to suddenly discover they can no longer qualify for the house they wanted. That situation will likely get worse and has an added impact on those on the lower end of the market whose rental rates will likely continue to increase.
While many seem concerned over corporate defaults as interest rates rise, I am not as concerned on this front. The credit default swap rates that we saw a spike in 2007 and 2008 are not signaling that as a problem yet as demand remains high and order backlogs should continue to bring in needed cash flow. Further, I never underestimate the ability of the American consumer to continue to do their job! (It is important to note that the increased consumer spending we are seeing over the past several months has less to do with consumer optimism and more to do with increasing prices.)
My last point here is that much to the chagrin of many who are reallocating their portfolios out of growth stocks based solely on quantitative factors is that higher interest rates mean a larger number in what industry professionals call the DCF or the discounted cash flow model. Simply put, this means that expected future prices of “safer,” less volatile stocks will decline. This same factor impacts traditional fixed income securities in a negative fashion.
Profit Positioning for 2022
While many easily forget that volatility is as old as the market itself, experienced investors never forget. We do not time the market for this very reason and we also tend to invest across sectors, and asset classes even when they are out of favor. We use portfolio management techniques that may seem unpopular at times that have, and we believe will continue to prove prudent, over the long term. Here are just a few things you can consider when positioning yourself to profit during a potentially bumpy 2022:
- Remember that volatility is a friend to the experienced investor
- Watch for and take advantage of opportunities
- Prudent and careful tax-loss harvesting
- Prudent and careful purchases of quality companies positioned well that may have been depressed in price while also not being afraid to look at businesses that may still be experiencing upward momentum. Avoid being tempted by the crowd that says, “it can’t go any lower;” It can.
- Beware of broad-based equity indices
- Carefully consider how much cash you need to keep on hand, so you are not forced into selling. Conversely, be wary of keeping too much cash on hand since currently, nothing in this area of the market is surpassing the inflation rate.
Those are just a few of the many things that can be done to position yourself to profit and mitigate large losses during volatile times. For more information we are easy to reach. Just text the word LIFE to 21000 or Click this calendar link.
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Please remember that this note is our opinion from a broad perspective and is not personal investment advice.
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John
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John Browning, MBA and CSA®
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