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In my previous article, I wrote that we are facing a panic moment that, on many measures, is far worse than 2008’s global financial crisis. The inflation outlook seems dire, financial conditions have become restrictive, and investor sentiment is at rock bottom. But financial conditions rarely remain in the same state for long. Market pendulums swing. And, of all the big ideas floating around – recession, deglobalization, energy shortages – none is quite as radical as the concept that markets may now be forming a durable bottom.
There is a larger trend at play here: The end of the fiscal austerity of the 2010s. Clearly, there is no policy appetite to return there. In fact, governments are under pressure to inject even more money into their economies to protect the public from the “cost of living” crisis. Germany’s recent €200 billion “defence shield,” which provides support for gas-importing companies, has extinguished once and for all any notion of fiscal restraint. Expansionary policies will drive growth higher over the coming years (even if fiscal conservatives will be holding their noses for a long time).
Yet of all the potential upside surprises, none is more crucial than the actions of the US Federal Reserve. Consider what is happening here. The Fed got the “inflation as transitory” view wrong and they are likely getting their policy wrong now too. To be fair, they have little choice. Restoring credibility is now their prime objective to correct for their earlier mistake. They cannot waver from a hawkish stance until evidence surfaces that inflation is coming down. That means they are hostage to incoming inflation data, operating without a forward-looking policy framework.
By contrast, investors are free to openly forecast the likely path of inflation. Here, evidence has surfaced that the Fed’s actions are working. Bond markets have brutally re-priced. Mortgage rates have doubled. In a matter of six months, financial conditions have quickly become the most restrictive in more than a decade.
Food, transportation, and housing account for 88% of the recent CPI. Each of these is showing decelerating price momentum. Commodities have corrected. Rental inflation is ultimately linked to the housing market. Falling home prices will lead to lower inflation there. Encouragingly, the dreaded wage-price spiral looks increasingly unlikely. All of this will pave the way for a declining trend in core inflation in the coming months and take pressure off the Fed. This is the foundation for maintaining a medium-term constructive view of markets.
Yet many will point out that market cycles did not bottom until central banks were deep into their easing cycles. This is true. The last two major bear markets (2000-01 and 2008-09) did not reach a bottom until interest rates reached their cyclical lows – when rates had reached sufficiently low levels to stabilize economic growth.
But the current market decline is clearly different from all the major bear markets since the late 1990s. The key difference is that those episodes occurred during a deflationary setting. Today’s bear is occurring in a strongly inflationary environment, which makes it more reminiscent of the 1973-74 bear market. In inflationary climates likes these, bear markets are driven mainly by rising interest rates, which cause a decline in equity multiples. The close negative correlation between rates and stock prices this year reinforces that view. But inflationary bear markets typically end once price pressures peak and most of the monetary tightening has been priced into other asset classes. All of this suggests that the current bear market is at a very late stage.
Bear markets are brutal processes, involving many re-tests, gyrations, and false breakouts. This wears down even the most patient of investors. Living through it in real-time can be agonizing. But patience is always richly rewarded. Markets have already radically re-priced: Yields are now higher and valuations are much lower. Expected portfolio returns should be ratcheted far higher from here.
Looking out to 2023, the macro backdrop will be completely different. By then, inflation, while still higher than the last decade, will be trending lower and central banks will be on hold. Markets will look past mild recessions. The key for investors is to recognize that major bear markets always signal a change in market leadership. The bursting of the global technology bubble is simply the first installment of a broader theme. Macroeconomic trends of the last decade have been punctured. The new combination of tighter monetary policy and looser fiscal policy means higher inflation and higher nominal growth.
The big investment opportunity is a secular revival in tangible investment classes in the real economy, ending the dominance of growth stocks. Investors will also need to look for exposures to sectors that are not reliant on low interest rates, but stand to benefit from higher public investment. Commodities and value stocks, with low valuations attached to them, are set for a long period of outperformance.
Whisper it, but a new bull market is quietly unfolding.
Tyler Mordy, CFA, is CEO and CIO of Forstrong Global Asset Management Inc., engaged in top-down strategy, investment policy, and securities selection. The Forstrong Global Investment team contributed to this article. This article first appeared in Forstrong’s “2022 Super Trends: World in Transition” publication available on Forstrong’s Global Thinking blog. Used with permission. You can reach Tyler by phone at Forstrong Global, toll-free 1-888-419-6715, or by email at tmordy@forstrong.com. Follow Tyler on Twitter at @TylerMordy and @ForstrongGlobal.
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Content © 2022 by Forstrong Global. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited. Used with permission.
The foregoing is for general information purposes only and is the opinion of the writer. The author and clients of Forstrong Global Asset Management may have positions in securities mentioned. Performance statistics are calculated from documented actual investment strategies as set by Forstrong’s Investment Committee and applied to its portfolios mandates, and are intended to provide an approximation of composite results for separately managed accounts. Actual performance of individual separate accounts may vary with average gross “composite” performance statistics presented here due to client-specific portfolio differences with respect to size, inflow/outflow history, and inception dates, as well as intra-day market volatilities versus daily closing prices. Performance numbers are net of total ETF expense ratios and custody fees, but before withholding taxes, transaction costs and other investment management and advisor fees. Commissions and management fees may be associated with exchange-traded funds. Please read the prospectus before investing. Securities mentioned carry risk of loss, and no guarantee of performance is made or implied. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.
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