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What’s Next?

This has been a year for the history books (and not in a good way financially), with both stocks and bonds declining in value at the same time. This has only happened three times in the past century with the most recent occurrence taking place over 50 years ago. Now, everyone is asking the same question: what’s next?

In our last webinar we discussed the folly of listening to prognostications of “what’s next,” even when those guesses come from the biggest names on Wall Street. By way of example, the average prediction last year for the S&P at the end of 2022 from fourteen of the biggest institutions on Wall Street was for the market to reach 4,984. The actual number turned out to be 3,839.50, a 30% miss. So, I will not entertain you with predictions of the future. Instead, let’s summarize the environment and what HCM is doing about it.

It seems clear that inflation, public enemy number one, is beginning to slow. The main two risks that would cause inflation to persist and interest rates to increase further are China’s reopening putting excess pressure on commodity price inflation and an unrelentingly tight labor market in the United States putting wage pressure on inflation.

Geopolitical risks abound, with the most concerning items being:

  • Possible Russia/Ukraine responses by the West;
  • Technology decoupling between the U.S. and China; and
  • Cyberattacks disrupting critical private sector and government networks. 

On the positive side, some argue that the market is already down so much that there is nowhere to go but up. Others talk about how rare it is to see two down years back-to-back. The best outcomes will manifest if inflation recedes from here without additional action needed by Central Banks or excessive pain in unemployment. Stocks could rally under this scenario; however, bonds would likely suffer as yield curves normalized.

Considering the inflationary pressures present today, Central Banks around the globe are increasing interest rates and indicating they will stay high for an extended time. At the same time the money supply is being reduced. These raise the cost of doing business and create competition for investment capital. The intent, of course, is to slow the economy and thereby inflation, even at the risk of inducing a recession.

The worst outcomes will arise if Central Banks must continue tightening the screws, bringing the economy to its knees in order to break inflation's back.

The consequences of a slower economy/recession will be increased unemployment and lower earnings, imposing valuation pressure on stock prices. This will, in turn, drive stocks lower while allowing bonds to profit from the weakening economic environment.

HCM was cautious during 2022. That posture served us well with both our equity and fixed income portfolios outperforming their benchmarks. We remain cautious going into 2023. Until the consequences on earnings from a potential economic slowdown or recession are recognized by the market, we believe caution will remain the most prudent policy.

Our cautious stance is manifested through our overweight allocation to value-oriented equities and lower duration securities. If upcoming earnings and economic data disappoint, we may reduce equity allocations in tactical portfolios.

Spending protection from bond ladders, guardrail spending discipline, and the higher cash flow from increased interest and dividends round out our bear market defenses. These tools give us the security of income that is in cash, dependable and growing, even when the market is in turmoil.

Return to January 2023 Newsletter

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