Rule #1 is you can only play the cards that are on the table. This is what we have been dealt…
Economy
“Safe” forecast is for a recession in 2023. The market will trade to the recession scenario until perceptions/evidence to the contrary present. Time frame on that? 2Q 2023.
We have not seen a rise in people losing their jobs…yet. When that starts, psychology will shift negative, but it also starts the clock ticking on the end of Fed tightening.
CPI “services” inflation proving tougher to bring down. Always has been. “Goods” inflation responding well due to supply chain health, higher interest rates on demand for big ticket items, and inventory bulge.
“Credit events”? Similar to the British pension problems, leveraged interest rate “products” (in Wall Street parlance) need to be unwound gracefully. The key: all are under water in the new higher rates for longer environment.
Corporate earnings 2023 projections moving to lower than 2022, broadly.
Long term rate of growth is 2% or slightly less – much like before Covid-19
The boost from fiscal policy is fighting with the deflation and liquidity tightening of monetary policy.
Federal Reserve/Monetary Policy
M2 level to declining
RRP rolling off domestically, though slightly at this point
QT pulling money out of the system. Key is liquidity, not rate…
The Fed’s rapid rise in rates will increasingly shift to “conventional’ increases. Think “dimmer switch” effect on the economy.
Fed does not want to “break something”: they’d have to fix it. And,
Fed wants to keep rate – they have been trying to get rate ever since 2008. Think rates higher for longer.
Fed is incented to pull excess (and idle) reserves out of the system: it has to pay interest on them.
Fiscal Policy
Current dramatically lower deficit simply reflects no stimmy checks, some increased revenue due to the boosted economy of 2021. But federal spending is still above “full employment” neutral target.
Infrastructure Legislation, Inflation Reduction Act and the CHIPS Act will boost the economy – and give a clue what sectors will do well
Political effects of the election
“Blessed gridlock” barely…and not all positive: econ boosting measures not likely, budget and debt ceiling stand-off odds increase, positioning for the 2024 will be underfoot starting immediately.
Roughly balanced chambers mean “dissenters” in each party have higher leverage.
Longer term trends
Movement of production either back home, near-shoring or “friend-shoring”
Electrification, greening, and fossil fuel displacement are all growth opportunities.
Oil policies continue to not make sense. Worldwide supply increasingly coming from state-owned oil companies and countries that are not necessarily our allies.
Cold war with China continues (phrase hat tip to Dr. Niall Ferguson). Taiwan will continue to be a flash point but may well be delayed as President Xi moves to implement Marxist societal reforms – his agenda.
Ukraine War is a war of attrition, with no obvious “off ramps”, Psychology is rising as a tactical weapon.
P/E “bear market” over? Hard to make case for P/E’s rising. Rates higher for longer, trends in ROE, and confidence in government will limit the “sentiment” element upside.
Rates higher for longer also means that the recent bond price declines are permanent losses…unless of course the scenario of a deep recession.
Pensions and other “defined benefit” obligations continue marching toward funding crisis.
Ultimate dichotomy: truly wonderful growth opportunities being created in almost any industry you look at. This combines with the dysfunctional (blocking/destructive) political environment.
Given the opening observation, managing your portfolio is, and frankly has been, a matter of 1) forming a view of the economy “on the other side” of the recession, 2) shifting toward companies well-positioned for that environment, 3) reducing high P/E risk, 4) having a bit of extra cash for opportune purchase, and doing so in a tax-sensitive manner. You’ll notice all of these elements have been operative in your portfolios, especially in the last several months
We have a way to go yet, so plan on a lot of negative headlines early next year. Those will be opportunities for portfolio upgrades.
Let’s get together in early December for a review.
Prior to that and as always, if you should have and questions, comments, or concerns, please give me a call.