Hugo Angelo Lucien Manenti
Edited
Hi all, First thing – let me wish you a happy, healthy and prosperous new year 2022! Mine started with a mild covid, but one that lingered on a bit – hence my focus on investing and lack of communication. All better now, and happy to be able to share my thoughts with you! I'll run through my outlook for the year in this post, and drill down into actionable investment ideas in an other post, later this week. 𝗠𝗮𝗰𝗿𝗼 𝗢𝘂𝘁𝗹𝗼𝗼𝗸 The macro this year will be dominated by the pace of tightening from the Fed, which will itself be related to growth, employment, inflation, and political considerations (Democrats will likely be wiped out in the midterm elections if they can’t get inflation under control). The Fed has been signalling a faster pace of interest rate hikes and quantitative tightening (reducing the size of its balance sheet) than expected, which has caused much stress this January – yields are up, bonds are down, and most long duration equities (think tech and growth) are suffering. 𝑪𝒂𝒖𝒔𝒆 𝒇𝒐𝒓 𝒄𝒐𝒏𝒄𝒆𝒓𝒏? 𝑪𝒆𝒓𝒕𝒂𝒊𝒏𝒍𝒚 Rate hikes and quantitative tightening will remove liquidity from the markets, impacting valuations – particularly for riskier assets. This has been anticipated by investors, to a degree, as shown by the drops in valuations of many small cap / growth companies since early 2021. What was not anticipated was the pace of tightening, which is likely to be quite fast, and is causing the large correction this January. Look at $ARKK as an example. 𝑺𝒐 𝒊𝒔 𝒕𝒉𝒆 𝒎𝒂𝒓𝒌𝒆𝒕 𝒈𝒐𝒊𝒏𝒈 𝒕𝒐 𝒄𝒓𝒂𝒔𝒉? Likely not. The reason behind the Fed's change in monetary policy is that the easing that started in March 2020 has achieved its objectives – the economy was saved, and employment has recovered. Unfortunately (as could be expected), this policy, alongside with huge government spending and supply chain issues, has resulted in very high inflation. So the Fed has every reason to go back to a more “normal” policy and focus on inflation. I do expect that inflation will come down naturally as customer spending normalises and supply chains improve, both of which seem to be happening already. Growth will be lower than last year but stronger than most expect, propelled by robust customer and corporate spending (as the pandemic ends), which will make up for a lack of Government / Fed support. If inflation decreases, it will give the Fed the flexibility to hike more gradually, without impacting the economy and financial markets too much. Such a scenario would actually be positive for equity markets. 𝑾𝒉𝒂𝒕 𝒄𝒐𝒖𝒍𝒅 𝒈𝒐 𝒘𝒓𝒐𝒏𝒈? 𝟭. 𝗜𝗻𝗳𝗹𝗮𝘁𝗶𝗼𝗻. China is taking aggressive steps to control the spread of Omicron, which could impact supply chains and result in continued high levels of inflation. It is also possible that a feedback loop starts in the USA, where high inflation means that salaries need to increase, causing prices to rise further, etc. If this happened, we could see persistently high inflation, low growth, and the Fed would be forced to become more aggressive. Stagflation - bad recipe for markets. I will certainly be watching supply chain and inflation data closely. So far, it seems that supply chains are improving, and inflation is coming down in China, which are good early signs. 𝟮. 𝗙𝗲𝗱 𝗽𝗼𝗹𝗶𝗰𝘆 𝗺𝗶𝘀𝘁𝗮𝗸𝗲. There is a real risk that the Fed tightens its policy too much, at a time when the economy is already slowing, and inflation is fading naturally. The conjunction of those three factors could very well result in a deflationary environment which would be unfavourable to cyclical and high-beta assets. 𝗖𝗼𝗻𝗰𝗹𝘂𝘀𝗶𝗼𝗻 It is a given that the government will spend less and that the Fed will tighten. This means that the economy will depend on (1) the propensity of households and companies to come to the rescue and spend their accumulated savings and (2) improving supply chains and lowering inflation. I do remain positive in my outlook and assume that companies and households will be spending, and that Omicron will be the end of lockdowns / supply chain woes. This should result in a generally positive environment for stocks, despite increased volatility due to lower liquidity and the end of the Fed backstop. In terms of timing, I would not be surprised to see a difficult Q1, as Omicron causes inflation to remains high and growth to decelerate, which is a bad mix when combined with Fed tightening prospects. However, I do expect inflation to decelerate and growth to pick up in Q2-Q3, as covid recedes and households are finally able to spend. Which means that my thesis might not play out just yet I will be tracking customer and corporate spending, supply chains and inflation as the main metrics to prove or disprove my base case. In the meantime, we'll have to accept the current market volatility - lots of bearishness and stress which are usually good opportunities to buy / add funds. All the best, Hugo $SPX500 $NSDQ100
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