FOR SEVERAL QUARTERS NOW WE HAVE RAISED CONCERNS OVER STOCK AND BOND HIGH VALUATIONS and of high inflation and rising interest rates. Fortunately, we have positioned client overall portfolios accordingly and have through diversification effectively ridden out much of the storm. Now, with markets trying to find a bottom at values not seen in a couple of years, we are becoming cautiously more optimistic.
THE MARKETS HAVE CONCLUDED that a recession is likely next year — will this become a self-fulfilling prophecy, as the Federal Reserve’s medicine kills the patient? The stock market seems shrouded in gloom. So the question becomes, is that fear of recession and declining corporate profits "built-in" already to stock and bond prices?
THIS WOULD BE THE ODDEST RECESSION in decades, with unemployment at 3.7% and plenty of Washington money still to be spent. Moreover, there are plenty of reasons for optimism — let’s look at a few that are prompting us to rethink allocations:
1. UKRANIAN TROOPS CONTINUE TO ADVANCE, perhaps not as quickly as their stunning counter-offensive in September, but make no mistake — Russia, humiliated, is still losing this war. And there’s a glimmer of hope that serious negotiations could begin this spring, after Ukrainians show the world that a cold dark winter will not break them.
2. CHINESE PRESIDENT XI JINPING is in no rush to invade Taiwan, and he wisely has toned down Zero Covid policies. In many respects, he’s a pragmatist, focused on trade and improving China’s economy.
3. U.S. ELECTIONS THIS FALL went smoothly — few allegations of voter fraud, and the political temperature seems to be lower in the U.S. Fears of American unrest have subsided.
4. MARKET-UNFRIENDLY POLICIES are have little chance of passage in the new Congress — no big tax hikes or ambitious new spending plans, as the Progressive Agenda collides with the right-wing House.
5. INFLATION HAS PEAKED, as energy prices fall and the economy begins to soften. Will the Fed get inflation down to 2%? That’s unlikely any time soon, but the direction is downward despite the hot labor market (which remains at this moment THE problem for inflation and the Fed).
6. WHETHER YOU LIKE HIS POLICIES OR NOT, the country seems relieved that Joe Biden has had a decent year — lots of legislative accomplishments, and he has unified NATO on Ukraine. Sources insist that Biden has not made a decision on running again; most pundits have believed that he won’t but that’s now a much closer call.
7. THE POLITICIANS WANT TO MOVE ON IMMIGRATION: The labor shortage is a huge drag on economic growth, and a more liberal immigration policy is warranted. An immigration reform bill could pass — if not this month, then at some point in 2023.
8. THE BUDGET DEFICIT IS PLUNGING, down from about $3 trillion two years ago to around $1 trillion now — still high, but the fixed-income markets aren’t worried, as a more restrictive spending mood emerges in the new Congress (except for defense outlays).
9. WASHINGTON GOT A WAKE-UP CALL ON ENERGY THIS YEAR: Renewables may be the wave of the future, but not yet. Even many Democrats concede that this is not just about drilling and exploration; it’s also about transporting fuel through pipelines and then refining it. The U.S. and Canada have loads of fossil fuels, which will continue to play a major role.
10. IT’S BEEN RAINING EVERY FEW DAYS IN CALIFORNIA, with more coming this weekend. The worst drought in modern U.S. history isn’t over, but at least it isn’t getting worse.
TO BE SURE, THERE ARE PLENTY OF ISSUES to worry about: A stubbornly strong job market, Iran’s terrorism, a possible over-reaction on interest rates from the Federal Reserve, a disturbing new flu and other viruses, the under-reported trade friction between the U.S. and allies, etc.
BUT GIVEN THESE TEN BITS OF PROMISE — we are now talking to clients about starting to reallocate to less defensive and more opportunistic asset classes. No crystal ball here (never found one that works), nor is this about "market timing", but rather is about being thoughtfully opportunistic. One thing our 40 years of guiding investors has taught us, adding assets never feels "comfortable" until it is well after the markets have bounced back. So while we believe market volatility will remain high, we will with appropriate caution try to get ahead of that inevitable turnaround.
Wishing you and yours a most Joyful Holiday Season! Bob and James