Based on questions I have been getting from clients I have collected a few thoughts. As always, the focus of the Kluge Wealth Advisory Group is on preparation and not prediction. We always need to be prepared for a wide range of events and outcomes and to carefully balance both risks and rewards.
First, there continues to be a lot of questions around inflation. The bottom line is that based on the data releases, inflation appears to be rapidly decelerating. There is a very large divergence emerging between the year-over-year inflation data and the trend in monthly releases. For example, data from the Bureau of Labor Statistics shows that over the last six months US consumer inflation has slowed to an annualized rate of 1.8% vs. the 6.1% for the full year of 2022. Similar patterns can be found in Canadian data as well.
Prices did rise at an accelerated rate in 2021 and the first half of 2022 but that process appears to have run its course. The end of accelerated inflation does not mean that prices will go back to where they were in 2020 but that that rate of increase has fallen to something approaching pre-COVID levels. I realize that based on the narrative we have all been consuming in the media that this is a significant change.
Secondly, I have noted in client conversations, studying survey data and reading the forecasts by key Wall St banks that there is a general consensus from both Main St and Wall St that we will see a pretty grim 2023. For example, based on data released by the American Association of Individual Investors on Dec 29th investors are now more pessimistic than at any time in the survey’s history. Furthermore, in their year-end predictions, many major Wall St banks are predicting a recession and further large drawdowns in equities over the course of 2023.
As I have heard remarked (tongue in cheek) by several market commentators – this would be the most predicted recession and “market crash” of all time if it were to occur. If everyone is expecting a result and then prepares for it, then it stands to reason that the impact of the event (if it occurs) will be limited. Very few predicted the Ukraine war and hence it has a major impact on markets.
This is why I always remember the old rule that was immortalized by Bob Farrell as: “when all the experts and forecasters agree then something else is going to happen”. To be fair, that “something else” could be more negative but given the gloomy mood, I feel that we are much more likely to run into a positive surprise than a negative one.
Maintaining an investment discipline in the face of “the herd” is very difficult which is why most investors do not do it despite the historical profitability of doing so. In all the noise we have been hearing, it is easy to forget that Q4 of 2022 was a positive quarter with portfolios rebounding on the back of strength in both equity and bond markets. Furthermore, there has been strength in sectors such as U.S. Homebuilding and Industrials which should not be doing well if the economy was about to experience a sharp contraction.
Third, after a very painful nine months, we began to see a rebound in fixed income assets take hold. This has been driven significantly by the decline in long term and medium interest rates that took place over the course of the quarter. Returns still look very attractive and the recovery has a long way to go but from all appearances it has begun.
Finally, we have been seeing a few questions about where we see the best opportunities going forward. On a risk-adjusted basis, longer term fixed income looks extremely attractive. There are several variants of this idea that we have used. The grim sentiment discussed above makes equities generally attractive. In that light European and Chinese equities screen well. We have added a small position through the Fidelity China Fund as a part of our international exposure. This fund has a long track record in the region and has displayed excellent risk management. In most circumstances I would avoid any exposure to any Emerging Market but given market and economic circumstances the VERY HIGH bar I set was cleared.
The picture painted by my “risk dashboard” remains cautiously optimistic about the path forward. As a result, we recommend that, where risk tolerance and objectives allow, investors consider reducing cash and buying both equity and fixed income. To repeat Warren Buffet’s old saying – we want to be greedy when others are fearful and fearful when others are greedy.
A positive longer-term view on the longer-term future does not preclude further short-term volatility. The key risk would be the one highlighted previously – that something worse than the already gloomy consensus occurs that sends markets to new lows.
These are uncertain times, but I firmly believe that by maintaining a disciplined approach and a long-term view and focusing on proven behaviors, we can profit from the current moment.
Please feel free to call anytime!
Thank you.
Conrad Kluge
Senior Wealth Advisor, Senior Portfolio Manager
Wellington-Altus Private Wealth
