We will experience volatile markets until the fight to control inflation shows signs of successPersistent high inflation is making a bad investment year looking even worse. Fed Chairman Jerome Powell, speaking at the Jackson Hole Economic Symposium on Aug. 26, 2022, reaffirmed the commitment of the U.S. central bank to keep raising interest rates until inflation is brought back down to the 2% goal. Reacting to the fears of recession created by this restrictive monetary policy, U.S. equity markets quickly gave back the gains that had been made during the brief early summer rally and finished the third quarter, on Sept. 30, 2022, at the low for the year to date.
All U.S. equity indices closed the third quarter in bear market territory, defined as a decline greater than 20%. The Dow Jones Industrial was down 20.95%, the S&P 500 -24.77% and the Nasdaq Composite -32.40%. (Source: Barron’s Statistics). Unfortunately, this negative performance carried over to the fixed income markets, where bond prices experienced the first global bond bear market in 70 years. The Bloomberg U.S. Aggregate Bond Index is down 14.6% for the year (Source: Bloomberg).
Consequently, and not surprising, the classic 60%/40% equity/fixed income allocation strategy, which worked reliably for decades, hit new lows for 2022. We are now in the most prolonged drawdown since the Great Recession of 2007-2009.
Fighting inflation now should enable a long economic expansion for the U.S.
As difficult and trying as this period has been for our financial portfolios, we are not abandoning our long-term strategy of diversified asset class investments tailored to your individual goals and risk tolerance. We aim to keep your investments properly calibrated to meet your long-term plans.
The significant increase in interest rates is intended to position the U.S. economy for a long and solid economic expansion lasting seven to 10 years, similar to what has been historically experienced since Fed Chairman Paul Volcker found success in bringing inflation under control, Powell said during his press conference after the Federal Open Market Committee meeting on Sept. 21, 2022.
We believe that a normalization of monetary policy (raising rates from close to the zero levels that prevailed since the onset of the Covid-19 pandemic) and reducing inflation toward the 2% target will set up our high-quality equity portfolios (consisting of profitable, dividend-paying, market dominant U.S. companies) to recover and prosper in the years to come.
Opportunities to earn decent interest finally return for savers
The silver lining in the significant corrections experienced across all financial markets is the emergence of attractive opportunities in U.S. fixed income markets. Short-term Treasuries are now providing yield greater than 4% from six months to five-year maturities.
For too long “cash is trash” was a pathetic way of describing the absence of attractive interest rates paid on traditional safe and liquid investments (savings accounts, CDs, short term bond funds, etc.). This is no longer the case, and highly conservative “cash equivalent” investments are now available with 4% or higher rates of return.
At Elevage Partners we have started deploying ultra-safe income strategies in your portfolios: building “ladders” in the short end of the U.S. Treasury curve. A ladder is simply purchasing substantially equal quantities of Treasuries across different maturities (as an example: six-month bills, one-year notes and two-year notes). As interest rates rise, the shorter maturity Treasuries are reinvested at a higher rate.
We firmly believe the U.S. central bank will win the fight against inflation. The Federal Reserve is using all its tools to normalize monetary policy (increasing interest rates and quantitative tightening by reducing the size of its balance sheet).
It’s uncertain when the Fed will be able to declare victory. We fully expect financial markets to remain highly volatile through the end of the year and into the first part of 2023. The financial markets have never experienced a combination of such a rapid rise in interest rates, a large-scale conflict in Europe (sadly the war in Ukraine is showing no signs of coming to an end anytime soon), international disruptions to energy supply and the lingering negative impact of a global pandemic.
Therefore, we will continue to stay defensive in our portfolio allocation. We’ll deploy new capital or cash into low-risk fixed income strategies until the inflation path becomes clearer. While difficult to assess with certainty, a significant portion of the necessary adjustments to the monetary policy have already been made. We believe this should lead to more calm financial markets in the not-too-distant future as the Federal Reserve begins to slow or pause its rate increases.
We encourage you to contact us with any questions about the markets, your specific long-term financial plan or any investment you would like us to review. These are unprecedented financial market developments, and we are on high alert to navigate those difficult times.
Chief Investment Officer
The information contained herein represents the views of Elevage Partners at a specific point in time and is based on information believed to be reliable. No representation or warranty is made concerning the accuracy of any data compiled herein. In addition, there can be no guarantee that any projection, forecast or opinion in these materials will be realized. Any statement non-factual in nature constitutes only current opinion which is subject to change. These materials are provided for informational purposes only and do not constitute investment advice. Any reference to a security listed herein does not constitute a recommendation to buy, sell or hold such security. Past performance is no guarantee of future results. The historical returns of any securities and/or sectors mentioned in this commentary are not necessarily indicative of their future performance.