As we approach the end of 2022, one of the most tumultuous years for stocks & bonds in decades, investors are now turning their eyes to 2023.
Will it offer relief? Perhaps recovery?
Or will the bear market resume and bring assets to deeper lows?
For insight, it helps to talk to those tasked with captaining client capital through the seas ahead.
Today, we’re fortunate to hear from Michael Green, portfolio manager & chief strategist at Simplify Asset Management.
The economy was set on its heels by COVID, an instability which the subsequent policy choices (i.e., extreme tightening of financial conditions) have exacerbated. This will likely manifest in a serious global recession in 2023.
Michael thinks it ironic that the opponents of central bank intervention when the Fed was easing are now cheering the tightening. In his opinion, if you’re against intervention, you should be against it in either direction. Excessive tightening can create big problems in the same way excessive excessive easing does.
Mike is a big fan of free markets and the signals they send to market participants. If left to work things out for themselves, markets will find equilibrium. But by constantly intervening, the central planners distort these signals and thus keep the system in a state of dis-equilibrium.
Much of the post-pandemic inflation we’ve seen Mike claims is less due to the stimulus issued & more due to the supply chain disruptions first, and now due to a policy increase in the cost of capital.
In Mike’s opinion, the Fed’s 2020 policy response prevented the US economy from spiraling into a downwards spiral after the country went into lockdown. But, it had a cost that needs to be paid AND it kept stimulating easing for far too long, especially after the fiscal side kicked in and the credit spreads came back down.
In terms of the markets today, Mike is seeing a lot of similarities between today and the 2008 crisis, where things were relatively contained until something major broke (Lehman). In particular, Mike’s very concerned that passive investment products have continued to experience inflows. The data shows that these passive inflows drastically distort prices in the direction of their flow. If they start experiencing outflows, triggered perhaps by substantial layoffs, they could bring the markets down big in a hurry.
And the danger now is that by hiking interest rates & causing bond yields to rise substantially, the Fed is incentivizing capital to flow from equities into bonds. This is putting pressure on those passive equity instruments, pushing them closer to the point at which their inflows shift from net positive to net negative.
To make matters worse, there’s a lot of political infighting amongst the top executives at the Fed. It’s not confidence-inspiring.
Mike thinks the Fed’s hiking/tightening regime will indeed “break something”. The disinflation we’re now seeing in many assets will build steam and may possible tip into outright deflation in 2023. The exact path & timing is hard to predict as Mike expects the Fed to alter policy in response (“pivot”) and that will make things more volatile. We also still have yet to feel the full impact of the many rate hikes the Fed has already made — those are going to be slamming into over the next few quarters (and the Fed is still hiking!)
So Mike is underweight equities right now, as a safety measure. He’s also bearing cyclical industrials, energy & companies with limited pricing power.