Inflation and the Bear: Slight Adjustments for Q4
October 24, 2022
2022 has been a substantial outlier, with both stocks and bonds declining significantly.
Global Equities vs. Global Bond Returns from 1977 to (Year-to-Date) 2022
The Federal Reserve is expected to announce another 0.75% rise in interest rates at their upcoming Nov. 1st meeting. While we anticipate that the Fed will maintain its hawkish stance to quell inflation well into next year, the U.S. has seen more recent moderation in the rise of inflation. Given that price pressures on shelter (e.g., housing) and services have remained stubbornly sticky, though, we expect inflation to persist well into 2023 (while not necessarily continuing to rise).
If incoming inflation data improves, in tandem with slowing the growth of money supply (which we already see evidence of), we could see signs of a slow recovery. We view this situation as unlikely, though.
Research has shown that it is difficult to time a market return (e.g., by moving to large cash positions and reentering the market). Thus, as of Q4 2022, we are not recommending any drastic portfolio adjustments. Instead, we are recommending a more surgical approach: with calculated adjustments primarily in response to current inflation reads, current corporate valuations (based on price earning multiples), and expected Fed interest rate hikes.
As a reminder, our overall investment approach is to set long-term portfolio allocations for each client; assess current market conditions quarterly; and make adjustments to optimize returns, while mitigating investment risk.
For Q4 2022, we recommend the following adjustments for equity holdings:
- Return to pre-2022 technology sector weightings. Since technology stocks have seen a significant decline in value this year, their relative weights in our clients’ original allocations are out of line with the beginning of 2022. Because interest rate increases hurt valuations in this sector, technology has taken more losses than any other investment segment this year. With the tapering of hot inflation readings, we recommend increasing the technology sector's weight back to its pre-2022 levels, in order to be in a position for when this sector shows signs of recovery.
- Reduce environmental, social, and governance (ESG) aware weightings. ESG stocks tend to contain more growth stocks (vs. less volatile value stocks), and our focus for Q4 2022 is to stay within the value sector.
- Emphasize lower volatility investment (vs. growth) outside of the U.S., in the emerging markets segment and developed international markets. We are waiting until both of these markets exhibit signs of recovery (which have lagged behind U.S. markets, thus far).
For fixed income:
- Increase allocation in mortgage-backed securities (MBS). Given this segment’s recent downturn, we believe there could be near-term, income-generating benefits.
- Reduce the weighting of Government TIPs, since rate sensitivity has subsided – and more traditional bond sectors can provide target income levels.
- Add 0-5 years (duration) of credit exposure – to provide diversification, while mitigating short-term interest rate sensitivity.