Investor optimism has faced increasing pressure during Q1 of 2022. Advisors and asset allocators are tasked with navigating high inflation, slowing economic growth, rising interest rates, and most recently, an escalating geopolitical conflict. As the fog of war creeps in, we recommend a disciplined data-driven approach to asset allocation and portfolio construction.
We believe the key question facing investors today is: Are we entering a prolonged period of economic contraction and negative earnings growth? If the answer is yes, then downside risk remains for equity and commodity prices (and fixed income, now offering higher yields, would screen as attractive). If the answer is no, and the global economy does not enter a recession, then there are investment and rotation opportunities to capture.
The preponderance of our data suggests that the recent market selloff has “priced-in” more than just uncertainty and indigestion surrounding the acceleration of monetary policy tightening (more rate hikes sooner). We believe escalation and extrapolation of risks surrounding Russia have forced the market to begin “pricing in” an oncoming recession. Our indicators continue to suggest low unemployment, high corporate investment, and resilient household consumption. We expect a peak in inflation and no economic recession during the next 12 months.
If our assessment of the economy and inflation proves accurate, and the FED stays flexible and “data-dependent” with rate hikes, then many investors have over-priced the fundamental risks facing markets today. As an example, bearishness, as surveyed by the American Association of Individual Investors, has averaged 47% over the last 4 weeks (as of March 17th). This level of bearishness is rare, standing 17% above average and experienced only 4% of weeks since 1988.
Understandably, transitioning from a loose monetary policy to a tight monetary policy is never “comfortable” for investors. However, history shows us that the 24 months after the beginning of a rate hiking cycle are rewarding for investors (using data since 1970). Rate hiking cycles begin when the economy is strong enough to generate inflation (demand outpaces supply) and unemployment is low. This is the state of the economy today, and we expect corporations and consumers to show resilience once again to the ratcheting up of interest rates and the cost of credit.
We continue to see evidence for maintaining economic optimism and underweighting fixed income in portfolios. Interest rates are normalizing for good reasons – high inflation, robust economic growth, and still low real yields. Within fixed income portfolios, we prefer shortduration credit (floating rate loans where possible) and inflation-protected treasuries.
We allocate the proceeds from being underweight fixed income to commodities. Commodities offer effective and efficient inflation protection for portfolios while also hedging prevalent geopolitical risks. Within commodities, energy is a key exposure that looks more attractive near-term than medium-term. We complement energy with allocations to metals (base and precious) and agriculture – both of which exhibit more impressive mediumterm supply and demand imbalances than oil.
In equities, we see less risk in US value and quality factors. As investor confidence returns and geopolitical uncertainty abates, we expect to increase portfolio exposure to undervalued international equities more leveraged to economic growth and higher interest rates (cyclicals, financials, and commodity exporters).
Opportunities and upside remain in the equity and commodity asset classes, but the texture of returns and leadership within those asset classes is expected to differ from the last 10 years. Please let do not hesitate to contact marketing@ accuvest.com if you would like to explore and discuss our real-time asset class preferences, portfolio positioning, or economic outlook.
Disclosures: This information was produced by and the opinions expressed are those of Accuvest as of the date of writing and are subject to change. Any research is based on Accuvest proprietary research and analysis of global markets and investing. The information and/or analysis presented have been compiled or arrived at from sources believed to be reliable, however Accuvest does not make any representation as their accuracy or completeness and does not accept liability for any loss arising from the use hereof. Some internally generated information may be considered theoretical in nature and is subject to inherent limitations associated therein. Any sectors or allocations referenced may or may not be represented in portfolios of clients of Accuvest, and do not represent all of the securities purchased, sold or recommended for client accounts.
The reader should not assume that any investments in sectors and markets identified or described were or will be profitable. Investing entails risks, including possible loss of principal. The use of tools cannot guarantee performance. The charts depicted within this presentation are for illustrative purposes only and are not indicative of future performance. Past performance is no guarantee of future results. Actual results may vary based on an investor’s investment objectives and portfolio holdings. Investors may need to seek guidance from their legal and/or tax advisor before investing. The information provided may contain projections or other forward-looking statements regarding future events, targets or expectations, and is only current as of the date indicated. There is no assurance that such events or targets will be achieved and may be significantly different than that shown here. The information presented, including statements concerning financial market trends, is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons.