Over the past few months several institutional investors have offered insights on how the markets were evolving given a laundry list of changing conditions, including rising inflation, a change in Fed policy to raise rates, energy prices, and slowing world growth…
In January 2022 Howard Marks of Oaktree Capital was interviewed on Bloomberg by Erik Schatzker. Marks gave his view of how market condition were changing at the start of 2022 and how investors could adjust. Schatzker asked Marks, “are you worried about inflation?” (1)
“I am worried. This is excessive. Everyone wants a little inflation. For years central banks have been trying to generate inflation and haven’t been able to do so. Excessive inflation is not desirable.
Higher inflation means higher interest rates and higher rates mean lower asset prices, and that’s what’s going on right now.”
Marks continues, “We will continue to have a recovery, but with higher rates the economy will be less stimulated.”
Schatzker asked Marks about the ‘Everything Bubble’ Marks described in August of 2021? Schatzker asks “has the bubble been pricked?”
Marks explains, “I don’t think the fed should try to manage asset prices, they should focus on the health of the economy. Rates have been artificially low and that helped the economy after the lockdown, but rates need to be higher.”
“Soft landings are hard to achieve”, explains Schatzker. Will Jay Powell succeed in engineering a ‘soft landing’?
“It’s hard for economists at the fed to get exactly what they want. It’s very difficult.”
Marks was asked how can one invest in inflationary times? He responds “One might want more floating rate debt, you want companies growing fast enough to outgrow inflation. Make little changes at the margin, I think. Buying good assets at attractive prices is the best Long Term strategy to grow your investments.”
He continues, “There are many reasons not to sell. Sell for the right reasons, not the wrong reasons… You can’t time buys and sells; famed investor Bill Miller says, ‘time is what matters, not timing’. Most people trade too much, to their detriment.”
In March of 2022, Joachim Fels of PIMCO explained the company’s cyclical outlook. In it he explained that investors need to expect lower returns; “We are exiting the ‘New Normal’… there is significant uncertainty looking forward over the next 5 years.” (2)
PIMCO titled their outlook “Anti-Golidilocks”. Fels explains this means an economy that is the opposite of a Goldilocks economy where the economy is not to hot and not to cold. This is what the economy looked like before COVID.
He explains that now, “the economy will be too hot or too cold due to stagflation. Consider the supply chain which is already very fragile, we are likely to see more disruption in the years to come. This is now much worse due to the invasion of Ukraine by Russia.”
Fels points out that in addition to stagflation, “we are likely to see asymmetric shocks. This creates winners and losers; an example of this can be seen with net importer of food.” Constrained food supplies of corn and wheat and higher prices due to the war in Ukraine create societal shocks for countries like Egypt. Prior to the war Egypt received 80% of its grain from Ukraine and Russia.
Another issue driving instability is the fact that monetary authorities are not going to ride to the rescue and save markets; this is due to inflation. In a recent interview, Chairman Powell of the Federal Reserve was asked, If the economy enters recession and inflation remains stubbornly high, are you willing to maintain tight policy and prolong a downturn to achieve price stability? Powell responded, “We are very committed to restoring price stability…” (3)
Fels continued, “We need to have healthy respect for the situation to decline significantly… It is important to be cautious due to the heightened risk of recession.”
When asked to describe what ‘Stagflation’ looks like Fels points to a range of factors at play.
First, higher prices for energy, food and metals.
Second, continuing supply chain disruptions, especially in industries that experience a decrease in the supply of inputs (such as semiconductors).
Third, tightening financial conditions, especially as the Federal Reserve raises interest rates.
And fourth, a hit to consumer confidence; rising prices and rates make consumers more cautious and in the long term this will lead to businesses being more cautious about hiring and expansion plans.
Fels explains, “The risk of recession is increased, but it is not the base case.” Fels continues, “The strategy by central banks is to shoot at inflation first and ask questions of growth later… they are trying to slay the inflation dragon. How will they do this? They have to be aggressive, that’s what Jay Powell is telling us. We are likely to see a 50bp hike at the next meeting.”
Fels reflects, “Only hawks go to central bank heaven…”
“This business cycle is only 22 months old but we are seeing very late cycle behavior. There is a very high probability we are in the last third of the expansion.”
He concludes in a sober tone, “It’s hard to have high conviction on anything given the current environment.”
In late April 2022, Jon Ferro talked to Mohamed El-Erian of Allianz on Bloomberg about the state of the economy, inflation and the change in Fed policy. (4)
El-Erian explains, “We are seeing payback for many years of artificial sources of growth… There is a broad appreciation that a soft landing is not very likely, the Fed is so late it is less and less likely.”
“My fear is the Fed will flip flop causing inflation to last longer and lack of growth to last longer. Today talking about 75bp hikes, last week it was 50bps. Having failed to ease of accelerator, the Fed will be forced to slam on the breaks, hurting the economy.”
El-Erian pointed out another troubling sign for markets and the economy… illiquidity. “Before Chair Powell spoke the 30yr yield traveled 30bp in 3 days. That is a sign of illiquidity. We haven’t talked about liquidity and credit risk… At what point does interest rate risk roll over into liquidity and credit risk?
I didn’t want to be right on inflation…
I didn’t want to be right on the fed being slow to act…
I don’t want to be right on illiquidity because if I am, we are in a far messier situation.”
El-Erian concludes, “It’s time to take chips off the table. I’m still cautious…”
A common thread for Marks, Fels, and El-Erian is the importance of managing risk. If you have questions or concerns about how to manage risk in such a dynamic environment, please feel free to reach out to me by email at email@example.com .
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