Let’s take stock of what happened last year to various asset classes and compare it in relation to the general market consensus. But before that, a bit about the Fed and their promises and market guidance.
One thing you have to give credit to the Fed is that ever since the GFC in 2008/2009, the Fed has pretty much managed overall people’s expectations, stepping up in time to avoid any major catastrophe. Therefore, the general public’s confidence in the Fed has grown stronger and many think that the Fed will come to their rescue in case of another major crisis. For that matter, the Fed has also given that sort of assurance to the markets.
So what’s the Fed saying now? With inflation rising above everybody’s expectations, the Fed calmed markets late last month by suggesting that it would indeed start a tightening cycle. Most importantly, they gave indications that it will be a shallow path for interest rates - meaning it will not exceed the Fed fund rate’s long-term target of 2.5% over the coming years. The equity markets liked that particularly the high multiple ones and the upcoming tech innovators.
The Fed also believes that they are not that perturbed by the almost 7% inflation and they would tame it down to bring it close to 2% by this year itself. All this is expected to happen while producing a 4% growth in the economy which is above trend, at a 3.5% unemployment rate which is at record low levels, and the Fed funds rate which is under 1%. These are the expectations the Fed is attempting to set for the markets.
But the markets are not fully buying into this idea. The pressure is already showing in the 10-year yields and they are showing signs of breaking out. A possible rise in interest rates by June 2022 is now clearly brought forward to happen in March.
While this may not cause any serious damage to the stock markets there should be rotation within the sectors. Money should flow out of the high-flying, no EPS stocks into value stocks with strong cash flows. Should the Fed turn more aggressive, the rotation will get more amplified.
With a sharply steepening yield curve from the start of the year, the banking stocks are on a tear. With an anti-fossil fuel regulatory environment restricting new investment, the energy companies are selling production at higher prices, and instead of plowing that money into exploration, that cash is being returned to the shareholders. With that formula, oil stocks should also do extremely well in the current scenario.
Other considerations include political upheaval in Kazakhstan and its impact on investments. Kazakhstan, geostrategically sandwiched between Russia and China, happens to be the world’s largest producer of Uranium. It will be interesting to watch what’s happening in Taiwan with China asserting its authority and how the semiconductor business is making big inroads into the US.
So, how did the other asset classes do last year? If you ended up last year holding a lot of gold in anticipation of hot inflation (gold being a historic inflation hedge), you got the hot inflation but gold was down 4% for the year. The dollar was expected to unravel under the pressure of extravagant deficit spending and money printing. We got all that but the dollar went up against most currencies.
Finally, treasuries and bonds which would normally be dumped under inflationary fears did very little for the year. The market always finds ways to shatter our expectations and humble us. If you were a perma-equity fan, you should have done very well last year and overall it was not that difficult to stay fully invested anyway. Nonetheless, this year should bring us a lot of challenges and maybe even better opportunities. Let’s stay focused.
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Abraham George is a seasoned investment manager with more than 40 years of experience in trading & investment and multi-billion dollar portfolio management spanning diverse environments like banks (HSBC, ADCB), sovereign wealth fund (ADIA), a royal family office and a hedge fund. Currently, he is setting up a hedge fund where foreign citizens can invest in Indian growth stocks like Tanla operating in hyper-growth markets like CPaaS.