One of the major stories – if not THE major story – for the capital markets during 2022 was the overall tardiness of the Fed in responding to rising levels of inflation. Despite inflation spiking everywhere in late 2021/early 2022, the Fed continued to pursue a policy of accommodative quantitative easing and low rates well into 2022. A reminder that the Fed was doing QE (money printing, bond buying, drive interest rate lower) well into March of 2022 and didn’t start hiking rates until last May. During 2022, the Fed went from doing nothing to starting to hike rates slowly to commencing the fastest rate hiking cycle on record. Their goal was to bring down inflation by tightening financial conditions and destroying demand. It’s working: inflation is cooling, housing prices are going down, wage growth is softening. Eventually enough pressure on the brake mechanism does stop the car. The same can be said for an economy: the Fed’s braking is working.
Today we can see it working in the services sector. Services PMI just dropped -7 pts in a month which is a MASSIVE fall. New orders lower, services employment softer, inventories contracting. There are likely some weather impacts included here, but you cannot ignore a -7pt drop. It’s real. We’ll know in the 2Q23 whether we were officially in a recession in 1Q23. Data lags but the impact of tighter conditions/higher rates is slowing growth and demand. Market consensus is the Fed hikes 25bps in Feb 2023 – what isn’t consensus is that might be the point at which they “pause”. I am in that camp. “Pause” = “go” for capital markets and risk assets.
Best opportunities we see in an environment in which valuation levels have reset and a new economic cycle is in the very, very early stages? All areas which have been very unpopular for the past 18-24 months. Small cap > large cap stocks, value > growth stocks, non-USA > USA, and both emerging markets and China look like they want to come out of their respective slumbers.
In the midst of volatility, opportunities always emerge.
Chief Investment Officer
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