Cheers to 2022. Our family had a nice holiday season, hope you can say the same. Our daughter Abby was home and one of our movie nights featured Don’t Look Up, the recently released, popular Netflix movie. I highly recommend it.
The movie is a cynical comedy with an all-star cast, ostensibly about a recently discovered massive meteor hurtling to earth with an apocalyptic outcome for Earth, all in a matter of months.
Startled by their discovery, two nerdy scientists go on a media tour desperately warning the public about the pending cosmic doom. They even get an audience with the President (Meryl Streep), but their warnings go unheeded until it’s too late.
The movie is an allegory about climate change and the politicization of science. I like to laugh - and this movie is really funny - so it’s easy for me to set aside the political agenda and just enjoy the humor on its face.
Well, here comes life imitating art. Did you see the news about a good-sized meteor that will pass perilously close to Earth this week? The date is January 18th, to be precise. No need to look up, however, as the big rock will pass no closer than 1.2 million miles to Earth while speeding by at a brisk 44,000 mph.
Astronomers consider that distance a mild close call. More good news, the next known meteor will not pass near Earth for another few hundred years, unless of course nerdy scientists discover new ones.
I’ve borrowed the cosmic allegory as we turn our attention to 2022. The financial meteor that we’re now tracking is the Fed Reserve and the expected financial impact date appears their scheduled meeting in March 2022.
That’s the timeframe in which the Fed is expected to finally start raising short-term interest rates. Investors should “look up” to appreciate the financial risks that materially higher interest rates pose for their portfolio.
In case you didn’t notice, we’re living in extraordinary times. A viral pandemic has dominated the headlines, but central bank monetary policy over the past two years has been truly historic. There have been pandemics in the past (Spanish Flu), but the Fed’s money printing spree since 2020 is unprecedented in human history.
I know, that reads melodramatic, but the fact remains the Fed has printed several trillions of dollars and pumped the cash into the US economic since 2020. I don’t have the space to discuss whether that was sound monetary policy, but it happened nonetheless and now we face the specter of outsized inflation in part because of the cash tsunami.
My BS detector tripped last year as the Fed repeatedly referred to the nascent rise in inflation as “transitory”, caused by supply chain problems that would work themselves out shortly.
Outside of the Fed’s ivory tower, you could look around and notice rising gas and food prices, empty store shelves, labor shortages, outsized consumer spending, large commodity price increases, huge government deficits and material wage increases. All these factors foster inflation, perhaps more chronic in nature than the Fed has portended.
It would not be the first time a Fed policy projection was wildly inaccurate.
In fact, since the fall, the Fed has completely changed its tune about inflation. In December, it literally said they’re retiring the word “transitory” and announced the elimination of quantitative easing, a fancy term for money printing, by March ’22. The elimination of QE is a precursor to raising the Fed Funds rate.
There’s mounting criticism the Fed’s recent moves are woefully late and concerns they’ve already lost control of the inflation narrative. If so, interest rates are going to rise sharply and quickly in 2022.
In 2021, investment grade bonds suffered their worst year since 1980, posting a loss for the year. Baby Boomer investors have never experienced a bond bear market. Chronic high inflation would cause meaningfully higher interest rates and a nasty bond bear market in their retirement years. Ugh.
The seven largest stocks comprising the S&P500 index are presently mega-tech companies. Together they dominate the total index market value and drive index returns, up or down. In the past, similar stock market concentrations have ended badly for investors.
High valuation stocks need low interest rates, it’s their oxygen. As interest rates rise, their valuation math turns negative. Case in point, in the first week of 2022, longer-term interest rates leapt higher over inflation worries spilling into the new year.
In the same week, mega-tech growth stocks dropped sharply on the interest rate news and are having a miserable January overall. It could be the iceberg tip should Treasury yields keeps climbing. In this scenario, high valuation stocks will get whacked even more, along with stock index investors.
For the past couple years, I’ve sounded like a nerdy scientist warning about the dangers of overvalued mega-tech stocks. It turns out my call was indeed early; COVID and free money were factors, for sure. However, like a broken clock, my outlook appears more accurate with the passage of time.
It is unusual to start a new year with such clarity about investment return drivers like this January: Inflation and Fed actions.
The key investment lesson learned since the Great Financial Crisis of 2008-09 is “don’t fight the Fed”. If the Fed changes its course regarding monetary policy, investors should take heed and go with the new policy flow.
As always, there’s opportunities presented by changing economic climates. Commodities, energy, real estate, senior secured credit and even value stocks appear relatively attractive, especially is inflation persists deep into 2022 – or beyond.
One of the most interesting asset classes right now is emerging market equity, which has been damaged by the sharp rise in the US dollar since 2020.
Based on US fiscal recklessness, the dollar doesn’t deserve its current popularity. We expect it to decline in the coming years. If that devaluation happens, emerging market equity will become even more compelling. Hold your nose and diversify.
Until next time, be well…Tim