De-Risk Now to be Nimble Later
It is the third worst H1 that the U.S. markets have ever seen. Inflation, the War in Europe, China lockdowns, and recession fears have all hit hard.
Bull and bear markets arguments continue: unemployment remains near historic lows, and job gains remain solid; however, consumer cash and business confidence have plummeted. Most of the yield curve has inverted, as growth and inflation worries collide.
We expect that the Fed may frame the robust labor market and high headline inflation phenomena as sound justifications to energize their ongoing tightening campaign. A pullback across risk assets is the targeted objective of the Fed’s mission, not a byproduct.
The Fed’s goal is to cool growth, dampen investment, and eventually pull down inflation via demand destruction. These efforts also raise the risk of a potential policy error – and therefore, may increase the probability of a recession. Nonetheless, we are mindful that the Fed has repeatedly demonstrated an ability to abruptly U-turn in recent years.
For these reasons: we continue to de-risk portfolios now to allow us to be nimble later. Our 1st half adjustments to reduce active risk have served us well. In collaboration with our partner, BlackRock, we recommend making the following adjustments to portfolios in Q3 of 2022:
- Target lower total portfolio volatility (value vs. near-term growth)
- Reduce appreciated sector tilts (e.g., energy)
- Add duration to fixed income holdings (for yield)
- Scale back highest yield credit and convertibles positions (risk reduction)