The Fed is Done and Stocks Will Run
In November of 2021 – two years ago – it was difficult to predict that global stock and bond markets were on the precipice of an inflationary/central bank bear market. At the time, world equities were “up and to the right,” and central banks, including our Federal Reserve, were sanguine about mounting inflationary pressure as simply “transitory.” During that time, equities and bonds took a serious bear market tumble. Global stock indexes declined 28-40%, while even “safe” bond indexes fell by 6 to over 40%, and neither have fully recovered. This period of zero return – two “lost” years – is historically unusual, and we believe it has finally come to an end, or will very soon, for a number of reasons and improved data metrics. Let’s dig in!
Inflation and Central Bank Headwinds Abate – Bullish
When inflation soared in the back half of 2021 to over 9% (from 2%), we warned investors that to thwart rising prices and protect income earners and retirees, global central banks and our Federal Reserve would have to begin a serious campaign of raising interest rates that would “beat up” inflation – along with stocks and bond prices. This warranted us to provide you with a more defensive portfolio with less stock exposure. The ensuing two-year decline of stocks and bonds was difficult for most investors – particularly those that did not employ risk management tactics. However, this period did provide time for the Fed’s work to heal the extreme inflation. As of yesterday morning’s Consumer Price Index (CPI) release, inflation has declined to just 3.2% – within striking distance of the Fed’s target of 2% and a long way from 10%! The internal data of inflation metrics continues to have downward momentum. Since past Fed and central bank rate hikes take months to affect inflation, we see inflation falling below 3% in coming months. These improving inflation metrics should keep the Fed at bay, removing the most significant headwind for stocks and bonds going forward. As we like to say on our trading floor, “The Fed is done, and stocks will run.”
Stock Prices at “Bargain” Levels – Bullish
As opposed to two years ago when stock indexes were “priced for perfection,” at a price-earnings ratio of 19x, stocks today are trading at reasonable, if not bargain, levels. The average stock trades today at approximately 14 times next year’s earnings or a “PE ratio” of 14x. These are levels most closely associated with the beginning of bull markets like we witnessed at the start of 2009 and 2001 or the bottom of the Covid bear market in 2020. Each of these periods signaled the beginning of significant bull markets, and we do not believe this time will be any different. Simply put, from a valuation perspective, stocks are a bargain.
Economic Growth is Resilient – Bullish
Recent data regarding the strength of the US and many other global economies continues to be stellar. The last report of US economic growth was a whopping 4.9% annual rate. This was better than expected and is surprising since one would have assumed that the Fed’s aggressive rate hikes would have depressed growth – but it has not. One of the reasons may be the amount of fiscal spending over the past two years that has kept GDP propped up. Regardless, we believe the risk of recession – a major headwind for stocks – is improbable.
Federal Reserve and Central Bank Forward Policy – Bullish
Though Fed policy was a headwind for the last two years, we believe it will now serve as a tailwind for stocks and bonds. Given the number of rate hikes over the past 24 months, the Fed and global central banks have wiggle room to lower rates should the economy soften more than expected, or markets become volatile for other reasons, such as an escalation of the tragic conflicts in the Middle East and Ukraine or the upcoming election. For the past two years, investors could not rely on the Fed to “save the day.” As we move forward, this powerful force should stabilize markets.
Artificial Intelligence – Tech-Driven Bull Market
In our view, we are not only at the beginning of a normal business cycle but one that will be led by artificial intelligence (AI) and technology. We believe AI will transform technology companies and just about all sectors of the global economy and lead to higher productivity growth – which is excellent for corporate profits and stock prices. The last time the world experienced a tech revolution was the internet era of the 1990s, which was an excellent period for stock investors. We look forward to this new era and watching the success of the companies in your portfolio as this revolution unfolds and progresses.
Increased Allocation to Stocks – With Risk Management
During the market’s last correction a few weeks ago, we purposely increased your portfolio’s allocation to be much more growth-oriented, given the alignment of the bullish metrics expressed above. There is an overweight tilt toward some of the best technology companies in the world, as well as diversification across most sectors of the global markets. We are optimistic about the next few years to say the least. However, keep in mind that after 30 years of managing assets, our team is also cognizant that sometimes our bullish case doesn’t come to fruition due to some unpredictable event. For that reason, our Active Risk Management process is firmly in place on all of your equity holdings. This includes our flexibility to reduce stock exposure, change your sector alignment, and our use of very carefully placed stop loss orders. This unique process has mitigated risk during catastrophic market declines like that of the last two years, or the Covid, 2008 or 2001 bear markets. We have confidence in our risk management process should our bullish outlook get derailed.
Assets Outside of Main Street Research – Window of Opportunity
This is an excellent time to put dormant cash or lesser performing funds outside of our management to better use in light of the bullish metrics that have developed and the opportunity for stocks and bonds going forward. If you have assets outside of our management and would like to add them to our work, simply let us know, and we can facilitate an easy transfer or have a discussion. It’s a great window of opportunity to leverage what should be a great bull market ahead.
We hope you find this more optimistic update helpful and look forward to a number of profitable years ahead.
If you have a friend or family member who would like to have us help them with this “window of opportunity,” please let us know or forward this Strategy Update to them, and we would be happy to assist.
Your Main Street Research Team