The Power of Powell

Federal Reserve Chairman Jerome Powell and the inclinations of the central bank remained the key debate last month as they attempt to lead the economy through a year of policy tightening to combat high inflation.

With the next Fed meeting now only a few weeks away, investors are eager for what’s to come. The mid-summer rally was largely predicated on rising expectations that the Fed may pause its rate hike campaign, alleviating markets from what has been steady, if not aggressive, policy pressures.

At their annual Jackson Hole summit last week, US equities fell sharply in response to Chairman Powell’s comments regarding the Fed’s mindset ahead of their next meeting. Powell implied a willingness to further raise interest rates and maintain them at elevated levels until they feel inflation is down to a comfortable level.

With many expecting another significant, 0.75% rate hike in September, which would be third increase of that degree this year, markets sold off on fears for what it would mean for the economy. In fixed-income, the US 10-Year Treasury yield was more stubborn in reacting to the Fed’s discourse, holding well above the 3% level.  

Our Perspective

The debate over what the Fed will or won’t do next is the top issue driving shorter term movements in financial markets. The central bank is caught between two subpar choices.

Driving down inflation will likely require demand destruction that pushes the economy into recession. And while they are loath to cause a recession, they also must maintain their inflation fighting credibility.

Given the choices, we see the Fed as on a warpath against inflation. In addition, we believe the economy is already showing signs of weakness, and as a result, the risk of recession in the US and other major economies has increased significantly.

As an active manager, we will continue monitoring macroeconomic developments and acting with caution as we de-risk portfolios and position for a slowdown.  

Enjoying the Ride?

This year has been a rollercoaster of market ups and downs. While everyone enjoys the ups, the downs can be difficult to cope with. Add in high inflation and a gloomy outlook, and investors can be left feeling hopeless and restless.

Yet, acting on these feelings by ‘just doing something’ can cause more harm than good.

Instead, shift your focus to these five timeless truths that will help reset your mentality to handle whatever the rest of the year has in store. We share all five in ‘Surviving Market Ups and Downs’.

Real Estate: Good for a Downturn?

There will always be investment opportunities, even with a more cautious outlook. Real estate is an area of opportunity that, when managed correctly, can be positioned to add value in both market ups and downs. Looking within the sector, we see select areas that are well positioned to withstand a downturn.

For example, medical office buildings have built-in, resilient demand as health care is an essential service and as hospitals further ‘offload’ exams, procedures, and surgeries to these off-site locations. Cell towers are another area with stable, long-term potential as carriers implement new 5G networks through tower upgrades.

Our Perspective

Both areas have long-term characteristics that should carry them through a downturn. These characteristics are top of mind for our research team as our outlook remains cautious. In the same vein, we’re actively making appropriate asset allocation adjustments to include more defensive positions within portfolios, from a stock-by-stock, bottom-up lens. Part of this exercise is identifying areas that, when managed correctly, can be positioned to provide a degree of downside risk management.

Our View
Economic Cycle		The economy is moving later cycle with speed; a recession in the US is becoming increasingly likely; the Fed is on a warpath against inflation, as it has found itself badly behind the curve and is being forced by high and persistent inflation to tighten into an already weakening economy
Stock Market		US stock market volatility has dramatically picked back up; market weakness, coupled with relatively robust earnings growth, has improved valuations incrementally; however, equities remain expensive by longer-term historical standards; elevated valuations may be partly explained by robust corporate profitability, as EBIT margins have climbed to historical highs; rising input costs are posing a risk to the ability of corporations to maintain this elevated level of profitability; returns will be harder to come by and stock selection will be increasingly important
Bond Market		Interest rates have risen well off their lows reflecting shifting expectations on inflation, growth, and central bank policy; corporate and municipal bond credit spreads have widened, but not enough to make them materially more attractive at this time
Important Issues on the Radar		COVID-19: the worst of this economic crisis is behind us, and with multiple waves of the virus, including the Omicron variant, the attention is shifting to learning how to live with the virus; potentially impacting recovery, financial markets and currencies regionally
		Ukraine-Russia War: we believe an environment of elevated geopolitical risks over the coming months would entail a general risk-off environment; lending upward support to the dollar, gold, and commodity prices
		China’s Economy: China is an outlier regarding policy and has shifted to a gradual loosening stance while most of the developed world tightens aggressively; debt and property markets remain major issues; trade tensions continue to impact global trade and supply chains
		Inflation: a confluence of massive policy stimulus, tight labor markets, gummed-up supply chains, and rising energy costs are causing inflationary forces to broaden and become more entrenched than previously expected; conflict in Ukraine and lockdowns in China have added to price pressures

Sources: Wall Street Journal

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