I hope this is a case of “in like a lion and out like a lamb.” January was not particularly kind to investors; volatility is back and will likely be here for a while. We got spoiled. For more than a decade, we’ve been in up-only and buy-the-dip territory; all that was required was patience. As the saying goes, all good things must come to an end. To be clear, this doesn’t mean that markets can’t or won’t go up, but it does mean that the overall conditions have changed, and so does the strategy required to navigate them.
In my opinion, markets have been driven by concerns over policy decisions to be made by the Federal Reserve. The Fed has turned quite “hawkish,” which generally means they want to tighten monetary conditions through raising interest rates and unwinding their purchases of government bonds. All of this is being driven by concerns over high inflation. To me, this appears more political than economic. True, we have all been dealing with rising prices on things like food, energy, cars, and many other things. Inflation is caused by too much money chasing too few goods; however, I don’t think that goes deep enough in this case to explain what’s really going on. You simply cannot discuss current inflation levels without considering the impact of Covid policies, changes in both consumer and employee behavior due to Covid and general demographics. In my mind, there are two different types of inflation at play. The first, which likely has already peaked, is demand-driven inflation. Demand was extraordinarily high in 2021 because the system was flush with money handed out by the government. There were direct-to-consumer payments that went into the hands of people who were very likely to (and did) spend or invest it immediately. That money is now gone, meaning that it’s either already been spent or invested, and the source (government stimulus) has ended, creating what some people refer to as a big fiscal cliff.
The second form of inflation is supply-driven inflation. The supply of almost anything you can think of has been reduced due to a combination of lack of production and shipping. It doesn’t take a math genius to understand that if the basic level of consumption can’t be met due to production and shipping issues, there is only one way for prices to go. This type of inflation is easily fixed, but it does take time. The one area that can’t and won’t be easily fixed is the labor shortage. There is no going back on this one. Three things have happened that have changed the workplace permanently. First, simple demographics. The baby boomers are older now, and they aren’t going back to work. Second, attitudes have changed because of Covid – they call it the Great Resignation – and many people have decided that they simply don’t want to trade their time for money doing things that are killing their soul. I look at this change in attitude much like the change in attitudes of children who lived through the Great Depression, whose experience impacted their financial decisions for the rest of their lives. Covid has done the same thing. The rise of the gig economy has forever changed how younger people choose to earn money. Lastly, the nonstop fear-mongering by traditional media, social media and politicians has scared a group of people out of working at places like Starbucks, Costco, retail stores at the mall and so on because they don’t want to be near other people for extended periods of time. Of everything I just mentioned, the availability and cost of labor will continue to be an issue indefinitely.
What does this all mean? It means that we may be going back to bad news, which is ultimately good news. The Fed has taken on inflation mostly because it’s being wielded as a political weapon right now, and they want to project an image of being proactive about it. Over time, however, the biggest threat to the economy is not inflation, but rather a slowing down of demand coupled with potentially bad Fed policy. If we are lucky, the economy will show signs of slowing earlier, rather than later, which could impact the Fed’s decision to continue tightening policy. The economy can take a few short-term interest rate hikes, but the bond purchases and generally tighter conditions might be more difficult.
Risk management is now front and center. For the next few months, we expect continued volatility, in both directions. That kind of market is hard to trade, even for professionals. Our plan is to maintain strong downside protection and to avoid the big drawdowns. The easy money has been made; this is where the best money managers earn their keep. We’ve learned that what separates the best from everyone else is not that they make more money when things are going well; it’s that they don’t get crushed when things go the other way. Rest assured, we have no plans to get crushed. We will be patient and wait for opportunities to knock. We have great systems in place and who we think are the best people to help guide us through these strange times. Rest assured; you are in good hands.
