2 Questions for 2022
Actionable Market Insights | Vision | Courage | Patience
As we welcome in the new year, there are two questions investors should ask:
Will the Fed find the right balance between inflation and interest rates?
What does the current Fed timeline mean to long term investors?
Ask better questions to find better answers.
Will the Fed find the right balance between inflation and interest rates?
This is a tough one. The Fed can always increase interest rates and intervene to stop inflation, which allows policymakers to go even harder on fiscal policy. The key for the Fed is to figure out the right balance.
The US bond market finished down 1.5% in 2021, its first down year since 2013 and only the 4th negative yearly return since inception of the Barclays Agg Index in 1976.
Friendly reminder: Bond investors get destroyed if rates rise, and bonds bleed off value if income from bond payments doesn’t keep up with inflation.
How do you raise interest rates from historically low levels without causing overblown debt to spillover and negatively impact other areas of the economy?
I don’t know.
What we do know: High inflation is likely to keep the Fed on a quarterly tightening path next year.
Bottom line: Bond math still doesn’t look good.
Wall Street expects the Fed to raise rates three times starting in March and to announce the start of balance sheet runoff, which is likely to proceed more quickly than last cycle.
See the timeline below offered by Goldman Sachs Global Investment Research:
Just take a look at a possible first rate hike, March! March will come much sooner than most people think. In my opinion, a timeline like the above would play out as a blockbuster movie, full of exploding negative yielding debt and fixed payout annuities.
What does the current Fed timeline mean to long term investors?
The Fed holding interest rates down in the face of inflation fears is bullish for equities in my opinion.
For individual stocks, historically, the highest profit margins have correlated with tight labor markets (e.g. before the crises of 1948 and 2008).
All else equal, a strong policy response in either direction over the year will probably favor value over growth.
Why?
Remember that Market cap-weighted investing makes an investor agnostic to where economic stimulus, rate hikes, or new tax laws are applied. If you own the same percentage of every company in the economy, then you don’t care where money flows.
Some Wall Street analysts suggest that as long as the economy avoids a further recession, short-term inflation expectations should come down substantially as people experience more moderate price increases, especially in energy.
Now, if an investor is able to know how potential policy actions will affect certain parts of the market, changing a long term investors’ asset allocation to overweight equities makes sense.
Of course, markets have sometimes reacted more strongly to Fed actions and 2022 could look very different from the timeline above.
This year will certainly be something to watch for, wishing everyone a successful year of investing!
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Best,
Darin Tuttle, CFA
Founder & CIO
Tuttle Ventures, LLC
